Taking a pension break could cost you thousands

Taking a break from paying into a pension might be necessary for a variety of reasons. Perhaps you opted out to save money for a property deposit quicker? Or maybe you took a career break that meant you were no longer contributing? Whilst it can make sense at the time, a pension break can have a significant impact on your long-term finances.

When you’re making financial decisions now, it’s important to consider how they might affect your retirement income. You may discover that the impact is minimal or affordable but it’s a step that can give you peace of mind.

There are two key reasons why a workplace pension break can have a far larger impact than you anticipated.

First, your contributions are likely to benefit from tax relief and, in the majority of cases, your employer will pay in too. So, it’s not just the money you’re putting in you need to think about but the additional contributions you’d lose too.

Second, pensions are typically invested and, as they’re not accessible until the age of 55, benefit from compound growth. It means over the long term your retirement savings can grow quickly. A pension gap will mean this growth slows down and your savings at the point of retirement could be lower.

The cost of opting out of a workplace pension

The true cost, of course, depends on many factors, including your salary, employer contributions and more. But research by Canada Life highlights how it can be far higher than expected.

Taking a ten-year pension break to raise a child means losing around a third (29%) of your private pension, the research indicates. For the average earner, this equates to £2,500 less each year in retirement. To bridge this gap, a 25-year-old taking a ten-year break would need to increase their pension contribution from 12% to 19% for the rest of their working life.

Due to compound growth, a pension break can have a far larger impact when you’re younger. A 25-year-old on the average salary would miss out on £800 a year in retirement after taking three years off, or around 10% of their monthly private pension. Under the same circumstances, a 55-year-old would only lose around £400 a year.

Andrew Tully, Technical Director at Canada Life, said: “Taking a pension holiday or a ‘gap’ year often costs around twice as much when you’re younger as when you’re close to retirement. That’s because the money you save earlier in life has more time to grow as an investment.

“Of course, a lot of these time outs aren’t something people can control. Illness and the need to look after relatives, for example, can come out of the blue, while bringing up children comes with its own financial sacrifices.”

5 options you have if a pension break will affect your retirement income

If a pension break could have an impact on your retirement plans, there are often things you can do with some careful planning. Among them are these five options:

1. Continue making contributions: If you’ve taken a career break, you can still contribute to your pension. You can do this through regular contributions or one-off lump sums. You won’t benefit from employer contributions, but you will still receive tax relief and, hopefully, investment growth.

2. Pay in more when you return to work: If you plan to start paying into a pension again in the future, increasing contributions can help plug the gap. However, due to compound growth, you’ll need to put in more than the amount you missed.

3. Delay your retirement: Working for longer gives you an opportunity to build up pension benefits. If you’re happy in your role, this may be an option for you. You can access your pension once you reach 55, even if you’re still in work. But it can limit how much you can contribute tax efficiently, so it’s important to check this first.

4. Don’t take a lump sum at retirement: When you reach the age of 55, you’re able to take a 25% lump sum from your pension, tax-free. It can be an appealing way to kickstart your retirement. However, the Canada Life research highlighted that not taking a lump sum at all could mean your annual income doesn’t suffer despite a ten-year pension break.

5. Adjust your retirement lifestyle: Finally, adjusting your pension plans to reflect a lower annual income is an option too. Be realistic about when you need to fund retirement when calculating if this is a feasible option for you. We can help you see how far your current pension provisions will go.

Don’t forget about your State Pension

It’s not just your workplace pension that may be affected by a career break either. If you’re taking some time away from work, whether to raise children or for any other reason, it’s worth calculating the impact on your State Pension.

Currently, you need a minimum of 35 years on your National Insurance record to qualify for the full State Pension. Whilst the State Pension is unlikely to be enough to support your retirement dreams, it’s often the foundation of retirement income. For 2019/20, the full annual State Pension is £8,767.20.

However, if your National Insurance record is below 35 years, you’ll receive a portion of the full State Pension. This could affect your retirement lifestyle.

There are ways to increase or maintain your National Insurance record. You may be able to buy back missed years or make voluntary contributions when taking a career break. There are also cases where National Insurance credits can help fill the gap. If you take time off to look after a child, for example, credits can cover this period when you claim Child Benefit, even if you don’t receive any monies from the benefit.

Considering your State Pension when taking a career break is an important part of planning for retirement. If you’re unsure of the impact or what you can do to fill potential gaps, please get in touch with us.

We’re here to help you plan financially. Whether you’ve already taken a pension break or could do so in the future, we can help you understand the impact and what you can do to fill a potential gap.

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