Cash clinic: Short-term pension cuts may cost you more in long term

Published on Friday 14 August 2009 20:01

Q I'M STRUGGLING financially each month and am looking to cut back on my expenditure. I'm thinking about cutting my pension contributions for a while. Is this a good idea? I'm not sure what else I can do.

HG, Edinburgh

A Wanting to cut your pension contributions during a time of economic hardship is understandable. However, you should consider the impact of this decision. Try to look at all your outgoings – yes, you have to live today, but your savings for retirement are very important and any reduction now has an even bigger impact on your standard of living in later years.

For instance, if you are a higher-rate taxpayer you would end up paying more income tax because you receive income tax relief on your pension contributions. So the net effect of stopping your contributions might not be exactly what you thought.

Some might argue that there is a case for trying to increase your pension contributions due to the tax relief received (although the government is doing its very best to make this as complicated as possible, which is strange considering our huge pension problem).

Another reason for not cutting pension contributions would be the fact that your pension is underpinned by investments. During a downturn, share prices are relatively low so you are able to buy more with the same amount of money. When the stock market improves, you benefit from this because you have more invested.

Growth within pension funds is also free of capital gains tax and this can make a big difference over time. If a pension fund and a non-pension fund were invested in the same way and the charges were the same, then the pension fund should be worth more at retirement due to the fact that you won't pay CGT.

Another benefit of pensions is that while the funds sit inside the pension "wrapper" and remain untouched, should you die the entire fund is not liable to inheritance tax.

We have a huge problem in the UK in that we are living longer and we don't save enough. The state has finite resources and we need to put our own funds aside for our future. It should not be seen as an option, but a necessity.

As a middle ground, if you are not sure about committing to a pension and locking the funds away, then invest but via an individual savings account, which is tax efficient and allows you to retain control of, and gives you access to, the investment. Then at the end of each year you could transfer some of this money across to your pension.

&#149 Gregor Munro is a financial adviser at HBJ Gateley Wareing

&#149 If you have a question you need answered, write to Jeff Salway, Personal Finance Editor, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or e-mail: [e-mail].

This above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.