Why you shouldn’t opt out of your workplace pension

Studies have shown a recent increase in the number of people who are opting out of their workplace pensions. Earlier this year, it was reported that opt-out levels at Nest, a pension scheme set up for automatic enrolment, had risen from 8% to 11% amid the pandemic.

A Pensions Policy Institute report stated that 20 million adults have seen their financial situation worsen during the pandemic. Twinned with rising unemployment rates, many have been left in a difficult financial situation.

With the financial turbulence the pandemic has caused, it’s easy to see why people might be looking for ways to reduce their expenditure – and opting out of a pension is one way to do this. Data also suggests that the youngest workers are those most likely to opt out of saving for their future.

Just three months into the pandemic, in June 2020, Royal London conducted a poll of 2,000 people and found that 40% of people aged 18 to 34 had already stopped or reduced pension contributions.

Your pension is likely to be the primary way you will support yourself in retirement when you are no longer earning an income. It is designed to give you the freedom to relax and enjoy your later years to the fullest. An inadequate pension could result in the need for a part-time job in your senior years, downsizing your home, or a complete change of lifestyle.

Read on to find out how opting out of a pension could negatively affect you.

Opting out of a pension scheme could cost you thousands

One of the main advantages when paying into a pension is that your employer will often contribute as well. As a minimum, your employer must typically pay 3% of your monthly wage into your pension, on top of what you already contribute yourself. The minimum you can contribute yourself is 5%, so a total of 8% of your wage is automatically added each month.

The government also provide pension tax relief, as an incentive for you to save for later life. Essentially, some of the money that would typically be taken as tax is instead put into your pension pot. The amount of tax relief you get is based on your rate of Income Tax.

As a basic-rate taxpayer, you will receive pension tax relief at 20%. Higher-rate taxpayers and additional-rate taxpayers receive 40% and 45% tax relief, respectively.

As a basic-rate taxpayer, every £100 contributed to your pension only costs you £80.

Another benefit of making pension contributions at a younger age is that you can fully utilise the effect of compound returns. This means, in simple terms, that any interest you earn from your savings can also earn interest. This results in your pensions constantly growing by a greater amount each year, even if you aren’t putting anything else in.

Even small contributions when you’re young can grow into a significant amount if left untouched year on year. But compound interest can benefit anyone, no matter your age, as compound interest over a 10- or 20-year period can still add a significant amount to your savings.

Reducing or stopping your pension payments could mean that it’s likely you will have to increase the amount you need to contribute later to achieve the same outcome. If you don’t, you could face a shortfall when you retire.

Even opting out of a pension later in life comes with significant drawbacks. You’ll be missing out on the “free money” gained from employer contributions, and the extra tax relief on your own contributions.

That is a significant portion of money that you could be turning down for your later life. Plus, you’ll be limiting the growth of your pension, further reducing the final amount once you reach retirement age.

Ways to boost your savings if you’ve paused or reduced pension contributions

If you’ve paused or reduced your pension contributions in recent years, there are several ways that you can make up any shortfall. There is no such time as “too soon” to restart them!

If you can, consider investing more than just the minimum rate into your pension. As you can see above, the greater the investment early on, the greater the payout. There is also the chance that your employer may match your increased payments, hugely increasing the growth potential of your pot.

If you can’t currently afford to add a little extra each month, think about creating a budget and identifying areas in which you can save on a monthly basis. By sacrificing a little bit of leisure money now, you could greatly increase your freedom in later life by boosting your pension contributions.

Make sure to talk to a financial planner if you’re unsure on what to do going forward. Your pension is crucial and requires plenty of contemplation; we can help devise a plan to ensure you have a suitable retirement fund.

If your pension is looking a little low, there are always options to make it “enough”. We can discuss how this can be achieved with you, be it through a change in your lifestyle, or perhaps rethinking when you may want to retire.

Get in touch

Email enquiries@prosserknowles.co.uk or click here to request a callback from one of our advisers.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.