According to the recent 2022 Retirement Report survey* by Scottish Widows, almost 11% of people in the UK are cutting back on making additional contributions to their pensions or have stopped making them entirely due to the rapidly increasing cost of living.

Although it is extremely concerning to hear that pension contributions are suffering due the current economic situation, it is unfortunately not surprising. Making financial decisions that will benefit you in the long-term is made significantly more challenging when there is a global economic crisis to contend with in the short-term.

The economic environment is presenting challenges for all types of saving, from cost increases causing people to dip into savings to make ends meet to 40-year high inflation reducing the value of existing savings.

What financial challenges are people currently facing?

The cost of living crisis and high inflation

Your ability to save for the future largely depends on the amount of disposable income you have and the resilience of your short-term finances. With the monthly cost of essentials predicted to increase by £200 over the next two years, the average person will have less money to spare and therefore less to invest in retirement planning.

Some inflation is good for the economy, which is why banks have an annual inflation target of 2%, but too much has the opposite effect. The average real wage has been declining since February when the UK inflation rate reached 6.2%. Since then, it has risen further to 9.1%, the highest rate in 40 years.

The average person will feel the worst effects of inflation in the rising costs of basic expenditures, such as food, energy, transport and rent. Soaring utility costs in particular are causing widespread financial difficulties, following the government raising the energy price cap in April this year. The average household bill rose by approximately £700 as a result, putting the average annual energy costs at £2,000 per year – double the cost of 2021. Worryingly, prices are scheduled to rise again in October.

The cost of non-essentials is also rising with a £100 increase in monthly terms since last year. These increased costs amount to greater financial pressure for households across the UK, making it significantly more difficult for people to save for the future.

Stagnating real wages

In addition to the challenges of the current economic climate, savers in the UK face the ongoing issue of stagnating wages.

Before the global financial crisis in 2008, real wages grew on average by 1.8%* each year (*figure adjusted to account for inflation rates). Wages fell as a result of the economic crash and they did not begin to recover until 2013. Recovery was gradual and real wages only returned to 2008 levels earlier this year.

High earners have been hit the hardest by wage stagnation, but the average earner has also felt the impact. Wage stagnation has been reducing the real term value of wages across the UK for more than a decade and less income means less capacity to save for retirement.

Spending cutbacks

Many people are reducing their spending to make ends meet in the current economic environment. The most common areas of spending that people are cutting back on are non-essentials such as leisure and holidays, however some people have had to resort to reducing spending on basic necessities including food and utilities.

When asked what their next course of action would be if living costs continue to increase, 8% of people stated they would withdraw from non-retirement savings and almost 5% of people said they would take on more debt to cope. (Scottish Widow’s 2022 Retirement Report*)

It is reassuring to see that there still seems to be an overwhelming reluctance to cut back on retirement savings, but it is concerning that even a relatively small proportion of the population have felt the need to do so.

Decreasing value of savings

One of the most significant consequences of high inflation is the negative impact it has on the value of your savings. Investment portfolios that have been created with the support of pension providers are likely to benefit from partial protection against inflation, whereas long-term savings in low-risk and cash-like assets are the most vulnerable to changing inflation rates.

Unfortunately there is a lack of knowledge among the general population in regards to alternative investment methods that could protect against inflation. 38% of people said they wouldn’t be comfortable with an increased risk of losing money, suggesting they would not seek or accept advice from financial experts on riskier investment options that offer more protection.

How could the cost of living affect retirement planning for you?

If you are a renter: People who rent their homes typically find it more challenging than homeowners to develop long-term financial resilience. You are more likely to feel the impact of the current economic situation than a homeowner, especially with increasing rent prices. Many people who rent also have ambitions to get their feet on the property ladder, however climbing house prices will make this even more difficult to achieve.

If you are self-employed: On the whole, you will face the same financial challenges as the rest of the population and will be required to make the same adjustments to spending habits. However, from a retirement planning perspective, you are more vulnerable than an employed person – 36% of self-employed people report that they have no retirement savings, whereas only 9% of employed people report the same. This disparity is largely a result of the automatic enrolment pension scheme, which affects employees but not the self-employed.

If you are nearing retirement age: People who are close to retirement age are most likely to feel the impact of the economic situation on their existing savings, as they are exposed to the effects of inflation. It is common for people to move their assets to cash and low-risk investments as they get older, but moving your assets too early can result in a significant loss in value for your investment returns over time.

Once you reach 55, you become eligible for early access to your pension savings. The current state of the economy may push people who wouldn’t have chosen to access their pensions early to do so in order to support themselves financially in the short-term, but premature pension access should be avoided where possible. Accessing your pension will trigger the Money Purchase Pension Allowance and the amount of tax-free money you can contribute to your pension will consequently reduce drastically from £40,000 to just £4,000.

If you are a wealthier saver: Although wealthier savers may not feel the immediate effects of inflation, you will eventually notice a decrease in the value of your savings – unfortunately the more cash you have, the more cash you stand to lose.

Increased inflation could also affect you if you have a defined benefit pension, as you may be at risk of breaching the annual allowance for pension savings and receiving tax penalties. If you have a defined contribution pension and your investments match the pace of inflation, you could also be at risk of breaching the lifetime allowance and being hit with tax penalties of up to 55%.

What is the UK Government doing to reduce the impact of the cost of living crisis?

The Government has introduced a number of support measures to buffer the impact of the current economic crisis for the people who stand to be most affected.

  • The National Insurance contribution (NIC) threshold has been increased
  • Fuel duty has been reduced
  • The basic income tax rate has been lowered
  • £400 grant for energy bills
  • £150 one-time council tax rebate
  • £650 one-time payment for the most vulnerable households

Although the Government has taken some positive steps, these benefits are partially offset by the rise in the main National Insurance rate and the four year freeze on both personal income tax allowance and higher earnings thresholds. Additionally, people on higher incomes do not stand to benefit from the support measures and will therefore remain considerably worse off as a result of the cost of the living crisis.

*Details of the data obtained from the various organisations is contained within the Scottish Widow’s 2022 Retirement Report.

The long-term verdict

The cost of living is likely to have a significant impact on the general population’s ability to prepare financially for the future. Although the impact will be felt to varying degrees according to life stage and financial status, millions of people across the UK are at risk of finding themselves without enough money to fund their retirements.

Charlotte Reynolds is an Independent Financial Planner with more than a decade of experience in the financial services industry. She recently completed an advanced paper in pensions (AF7 – Pension Transfers), demonstrating her ongoing commitment to delivering the highest quality support in retirement planning and other areas to our clients.

The most effective way to guarantee a secure and comfortable retirement for yourself is to seek retirement planning advice from an independent financial expert. Contact us today to speak to Charlotte or one of our specialist team. We offer comprehensive advice that is tailored to both your current and long-term needs.