Make this pension mistake and lose £36,000!

by Rachel Wait on 13 August 2009  |  20 comments
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Make this mistake with your pension before you retire and you could lose £36,000 or more.

When you think about retirement, what do you imagine? Kicking back and making the most of your free time, doing a spot of travelling, spending more time with your family, pottering about in the garden?

Whatever your plans, if you want a comfortable retirement, you'll need to ensure you've got enough money to support this lifestyle. If you don't have enough, your retirement plans may just disappear out of the window.

While preparing for your retirement might seem logical, sadly, more and more of us are starting to sacrifice our pension pots - threatening our retirement plans. In fact, according to Prudential, over the past five years, more than one in ten people have reduced the amount they pay into their pension or have stopped contributing to it altogether.

Prudential reckons this decision to stop paying into a pension could mean a rise in pensioner poverty in years to come, as the number of people who expect to rely on state pensions and their own savings is expected to rise by 27% in the next 10 years, compared with 22% of those retiring this year.

Why you should keep on contributing

When times are tough, it can be particularly tempting to cut contributions to your pension, or, if you haven't yet started a pension, to put it off for a bit longer.

But delaying your pension in any way can seriously affect how much money you have when you come to retire.

The chart below shows how much money you could lose out on if you decided to delay starting your pension for a few years.

These figures show an estimated pension fund, based on the individual shown starting a pension and paying £100 per month and retiring at age 65.*

Source: Prudential

By delaying your pension by just five years - starting aged 35 instead of 30 - you'll lose out on a hefty £39,240! Now if you ask me, that's a lot of money to be sacrificing.

If you postpone your pension even longer, the difference will be even greater. So by starting your pension at 40 instead of 30, you'd lose out on £68,670 and if you delayed your pension until you're 45, you'd sacrifice a whopping £90,730!

The reason you'd lose out on so much money is simply because pensions need time to grow. Thanks to the miracle of compounding, the earlier you start your pension, the longer your investment has to grow and the bigger your pension pot will be when you retire. If you don't believe me, take a look at How to double your pension.

Even if you have already started your pension and think you can afford to forgo your contributions for a few years and make up for it later on - think again.

The chart below shows how much money you could lose out on if you took a five year break:

These figures assume an investment of £100 per month, retirement age of 65, and a growth rate of 7% per annum less an annual management charge of 1%. Assumes inflation rises at 3% a year.

Source: Prudential

This chart clearly shows that simply taking a five year pension break can significantly lower the amount of money you'll have in your pension pot by the time you come to retire.

At the very least, you'd lose a whopping £36,000.

Even if you think you can add extra funding to your pension pot later on to make up for this, you'll struggle. And that's simply because that investment will have less time to grow.

The earlier you take a pension break - and the longer you take it for - the harder it will be to make up for that loss and the more damage you'll do to your pension pot.

Tax relief

Pensions are also one of the few things in life that allow you to benefit from tax relief. So this is another reason not to sacrifice your pension. You're getting 'free' money from the Government!

If you're a non-taxpayer or basic rate taxpayer, you'll benefit from tax relief of 20%. This means that every £80 you pay into your pension will be boosted to £100. If you're a higher rate taxpayer, you can claim back 40% of tax relief - so every £60 you pay in will be increased to £100.

Don't throw this opportunity away!

The stock market

Of course, if you have a share-based pension fund, chances are you've been feeling a little peeved following the dire performance of the stock market over the past year or so.

That said, the FTSE 100 is slowly starting to make a recovery and although we're not out of the woods yet, things are looking up.

In fact, I would argue that now is a great time to be investing in your pension - particularly if your retirement is still a long way off. Regularly contributing to your pension while share prices are still pretty cheap means you'll be able to buy more shares for your money. These shares are then poised to take off in value when the market picks up again - hopefully over the next few years. And that means more profit for you.

It's worth keeping in mind that if you cancel or delay your pension payments now, and the stock market does recover, not only will you have missed out on buying shares at a low price, but you will have also lost out on a tasty return from the growth of these shares. And when you finally do start investing again, if prices are high, you'll get a lot less for your money.

Our sister site, Fool.co.uk, offers some of the best investment advice in the country. Take a look.

Alternative cut backs

If you're struggling to find enough spare cash to invest in your pension each month, or even start a pension in the first place, one of the best things you can do is start to budget. By working out what your outgoings and earnings are, you'll be able to see whether you can make any cutbacks elsewhere - such as eating out less often or cancelling your gym membership. You can then put this extra cash towards your pension.

So while stopping your pension contributions might seem like the logical thing to do when there are other bills to pay, avoid doing so if you can. What might seem like the best option now, could turn out to be a big mistake later on in life.

Don't forget to check out our prepare to become a pensioner goal.

*Figures are purely illustrative and assume a growth rate of 7% per annum less an annual management charge of 1%. Assumes inflation rises at 3% a year. Based on a retirement age of 65 and a level £100 monthly contribution into a unit linked fund.

Apologies for the initial incorrect figures in this piece and thanks to dd for helping us to correct this mistake.

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