Why making cost of living cutbacks could harm your long-term savings

Writer,

The cost of living crisis is impacting everyone in the country. We’re all seeing our bills increase, and our wages failing to keep up. But while it can be tempting to reduce the amounts you’re putting into your savings, investments and pensions, you need to think about the long-term impact making such cutbacks will have.

For more help on how to battle rising costs, check out our special cost of living podcast.

Research we carried out recently found that 15% of 18–34-year-olds have already cut their pension contributions because of the cost of living crisis. And a further 25% are considering doing so. Similarly, 16% of the same age group have already cut back on their ISA contributions, with another 22% planning to do so when rising prices get too much.

This is far higher than older age groups. Only 21% of those aged 35–54 have cut back or plan to cut back on their pension (the combined figure for the younger age group is 40%), while 23% have either cut back or plan to cut back their ISA contributions (compared to 38% for 18–34-year-olds).

The good news, though, is that women are less likely to make cutbacks than men. If we look at only people who have a pension, 12% of women have already cut their pension contributions, against 17% of men. And 18% of women are considering cutbacks, compared to 22% of men.

For people with ISAs the figures are more even. 23% of women with ISAs have made cutbacks, compared to 22% of men. Meanwhile, 20% of women plan to make cutbacks, against 27% of men.

What’s the long-term impact of these cuts?

To give you an idea, let’s consider a 30-year-old on a salary of £30,000 who’s putting 8% into their pension a year (including employer contributions). Pausing their pension contributions for three years could cost them £15,000 when they reach state pension age.

If this person stayed in their pension scheme and carried on contributing, they could have a fund worth £289,000 by their 68th birthday. But by cutting their contributions for three years, they would have a fund worth £274,000 at age 68* instead.

By pausing their contributions, they’re turning down free money – in the form of a matched employer contributions. They’re also missing out on tax relief from the Government.

If they wanted to make up that shortfall in the following years, they’d need to increase their pension contributions to more than 10% of their salary for the five years after they resumed their contributions. If they wanted to make up the shortfall over three years, they’d have to raise their contributions to 12%.

Clearly for some people, making cuts isn’t a choice. They need the extra money to live on and make ends meet. But for those who might be able to make cuts elsewhere, it’s worth thinking about the longer-term impact on your wealth.

If you do have to cut your contributions, it could be a good idea to set up a calendar reminder for six months’ or a year’s time, so that you can revisit whether you can afford to start them up again. This removes the danger of cutting your pension contributions and forgetting about it, taking a much longer break than you intended to.

*Assumptions: Salary rises by 2% per year, investment returns = 4% per year, 8% pension contribution based on total salary.

Tax treatment depends on your individual circumstances and rules may change. Pension rules apply. Remember that the value of investments can change, and you could lose money as well as make it. Past performance is not a guide to future performance. Forecasts are not a reliable indicator of future performance.

These articles are for information purposes only and are not a personal recommendation or advice.

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Written by:
Laura Suter

Laura Suter is Personal Finance Analyst at AJ Bell. She is a multi-award winning former financial journalist, having specialised in investments. Laura joined AJ Bell from the Daily Telegraph, where she was investment editor. She has previously worked for adviser publications Money Marketing and Money Management, and has worked for an investment publication in New York. She has a degree in Journalism Studies from University of Sheffield.


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