The economic impact of the Coronavirus pandemic has hit many households across the UK leaving individuals searching for ways to cut costs. Reducing your outgoings is an obvious place to start, and many people are considering cutting back, or even pausing their pension contributions in order to free up some capital with which to ride out the pandemic. However, before you rush to stop your contributions, it is important that you understand the massive impact this might have on your retirement.
Albert Einstein referred to compounding as the eighth wonder of the world, but what is it and how does it affect you? Compounding is the process of growing, and in this instance it is the effects of interest on the accumulation of wealth. The best way to explain the impact of compounding on your savings is by example. Let’s assume you have £100 earning 5% interest. After a year this will be worth £105. The following year, this amount will not only earn interest on the initial £100, but also on the £5 earned the year before, leading to a balance of £110.25. After five years this will grow to £128 and after 10 years the balance will be £163.
What Does This Mean For Your Pension?
Compounding affects us all, whether it be the compounding you earn from your savings, or conversely from your debt. However, younger savers are most affected by compounding, with Aegon suggesting that a 25 year old saver, with a workplace pension scheme, who suspends their pension contributions for the next three years, could see the end value of their pension decrease by 7% as a result. To put this in monetary terms, the average earner could lose as much as £15,000 off the value of their pension at state pension age. However, the same earner who suspends their pension now for three years would be £4,000 better off over that entire 3 year period. These calculations do not take into account lost tax relief and loss of investment growth. From this, you can see that the returns from suspending contributions now, do not outweigh the effect on your wealth down the line.
You might consider our Guide to SIPPS and Personal Pensions for comparing pension providers and getting all the information you need.