According to the Telegraph, since former chancellor Kwasi Kwarteng’s revealed his “mini-Budget”, mortgage rates have risen faster than they did during the 2008 financial crisis. It’s a stark reminder of how the rising cost of living is affecting many homes across Britain, with the typical household now facing an energy bill of around £2,500, even with the government’s interim energy price guarantee.
In September, the Independent revealed that food inflation had reached an all-time high of 10.6%, with 75% of Britons saying they will be “moderately or severely affected” by the cost of living crisis. If your client is one of them, they could be considering ways to reduce their household expenditure.
One way they may be thinking of doing this is to pause their pension contributions. If so, care needs to be taken as research by Standard Life shows that stopping contributions, even for a relatively short period of time, could jeopardise their retirement lifestyle.
Read on to discover more, and how your clients could reduce their costs while keeping their retirement plans on track.
9 out of 10 households may be affected by the cost of living crisis
Standard Life’s research suggests that 93% of homes are feeling the effects of increasing costs. The pension provider, which questioned more than 2,500 people, also found that 77% of those asked said they expected to cut back on spending or savings.
Of those households earning up to £30,000 a year, 80% said they would need to reduce their spending, while 72% of households with incomes of between £70,000 and £100,000 a year said they would be cutting back.
More than half (56%) of households earning more than £100,000 said they would also need to reduce spending.
Interestingly, Standard Life found that one way some of those questioned were thinking of doing this was to postpone or reduce contributions to their pension pot. Let’s look at this next, and why it could jeopardise your client’s retirement plans.
A short-term pause in contributions could reduce your client’s pension pot
According to Standard Life, reducing or stopping pension contributions could have a significant effect on the value of a pension pot, even if they were stopped for a relatively short period of time.
To demonstrate this, Standard Life worked out the value of a pension pot based on the holder earning £25,000 a year and making monthly contributions of 3% from the age of 22. These were also boosted by a 5% employer contribution.
In this scenario, the pot would be worth £456,893 when the pension holder reached the age of 68, based on an average investment growth of 6.25%, salary growth of 3% and annual inflation of 2%. It also assumed annual investment costs of 1% a year.
If pension contributions were stopped at the age of 35 for just one year, the pension pot would drop to £444,129 in value, almost £13,000 less than if contributions had continued. Standard Life also found that if contributions were stopped for two years the pension pot could be reduced by around £25,000, and if they were postponed for three years, it could fall by nearly £38,000.
Please note that the calculations were only intended for illustrative purposes and should not be used to accurately represent what might happen. Still, the calculations do highlight an important point, which is that using a pension to deal with a short-term financial issue might jeopardise your client’s long-term lifestyle and financial security.
Your client could reduce their expenditure without jeopardising their retirement
There is some good news though, as your client may be able to reduce their household expenditure without putting their retirement plans at risk. Let’s look at two ways they could achieve this.
Create a budget
Your client could get a clearer idea of their expenses and what they can afford if they create a budget. It also means that they can break down their spending into categories such as food, mortgage and travelling costs and see exactly how much money is needed to cover them.
This could prevent overspending and identify areas of spending they can cut back on. For example, it might highlight that they are paying a subscription for a service they don’t really use, allowing them to stop it and reduce monthly outgoings.
Calculate their personal inflation rate
The Office for National Statistics (ONS) calculates the nation’s average inflation rate based on a “basket” of more than 700 goods and services. It’s unlikely that your client’s spending will exactly match this basket of goods, meaning their personal rate of inflation is likely to be different.
Working out their personal rate allows them to see the effects of inflation on their own finances. To calculate their personal expenditure, you client needs to add up their regular monthly expenditure and compare it to previous years.
For example, if they spent £3,600 in September 2022 and £3,000 in September 2021, their personal inflation rate increased by 20% in the year between. This could prompt them to look more closely at their expenditure and make cutbacks.
Get in touch
If you or your client would like to discuss their retirement plans or pension, please contact us on hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you will have peace of mind that your clients will receive excellent advice and the highest quality service.
Please note
This blog is for general information only and does not constitute advice. Please do not act based on anything you might read in this article, and all contents are based on our understanding of HMRC legislation, which is subject to change.
The information is aimed at retail clients only.
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. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
