Cost of living crisis – should you dip into your pension pot or stop paying into it?

It was widely predicted that the Consumer Price Index (CPI) would drop to 8.4% throughout May 2023, signalling a slowdown in inflation. However, on 21st June it was announced that inflation had held firm at 8.7%. In June the CPI was 7.9% which dropped to 6.4% in July. One way that the Bank of England seeks to curb inflation, is to raise interest rates. Thus, the day after the CPI announcement, the Bank of England raised the interest rates for the 14th month running, from 5% to 5.25%. One onward impact of this is that mortgage rates increase, leading to higher mortgage payments for homeowners. The cost-of-living crisis is already depleting disposable income and savings individuals may have had. With inflation not slowing down, this is set to continue for some time yet.

So, if you’re struggling to meet your financial obligations, should you take money out of your pension pot to supplement your income? Or take a break from paying into your pension to free up some additional cash each month? Here we’ll discuss the impacts these options may have on your retirement.

Taking money from your pension pot.

It should be noted that the option to take money out of your pension pot is only available if you are over 55. The good news is that the first 25% you release from your pension pot is tax-free! That will certainly help to take the pressure off financial problems in the short term. Less favourable, however, is that the withdrawals of more than 25% of the full pot could trigger income tax at the emergency rate. This is because the withdrawal will count as income, and HMRC may see this as a regular payment you’ll receive for the remainder of the year. The emergency tax rate could be the same as the basic rate of 20%, but it does not consider the £12,570 tax-free allowance, as regular basic tax does. You will therefore begin paying more tax. This problem can take some time to solve with HMRC, which could nullify any gains made from the pension pot withdrawal.

An additional factor is that if you withdraw more funds than you initially need, this could be detrimental to any benefits you receive. For example, Universal Credit has a cap on the amount that you can have in savings, as an eligibility factor. Leftover funds from a pension withdrawal may tip you over that cap.

Taking a break from making payment contributions.

The purpose of temporarily pausing pension contributions would be to boost the value of your take-home pay, giving you more disposable income. However, this will not necessarily be the case. When you are making pension contributions, the money you pay is not taxed. However, if that money is added to your pay packet, it will be included in taxable income. Therefore, you are unlikely to receive the full amount you would have paid to your pension, in your pay packet. Of course, you may feel that any additional income is better than none. These calculations should be weighed up first, to ensure you’ll receive what you’re expecting. Not only will you be taxed on the money that would have been tax-free going into your pension, but you will miss out on the tax relief – additional funds into your pension.

So should you use your pension to boost the money in your pocket?

It is easy to see how people may think releasing funds from their pension will ease their financial burdens during these difficult times. It can’t be denied that this is true. However, before making this decision the benefits versus future impact should be weighed up. It may mean you are unable to retire when you had planned to or may not be able to afford the retirement you had hoped for. Having said this, these are unprecedented times. Sometimes the need to free up some funds is greater than the concern about what may happen in the future. In this instance, we would advise you to recommence contributions to your pension as soon as possible. Or if you have drawn down funds from your pension, try to pay in a lump sum or make higher monthly payments as soon as is practicably possible.

Could you have missing pensions from previous workplaces? We can help you find your lost pensions for free! This could provide you with funds to top your active pension back up or reduce the need for pausing contributions or taking funds from your pension. Find out more about our pension finding service here.

We acknowledge that some may not have the luxury of worrying about their retirement at this time. However, we firmly believe any decision regarding your pension should be made from an educated standpoint. Do you have any other options available to you? For example, do you have savings or investments you could withdraw instead of your pension? If you’re still confused about your options, we’re here to help.