Risk to retirement income as savers reduce their contributions

Some savers are cutting their pension contributions in response to higher living costs and recent stock market volatility which has hit returns.

Although this might free up extra cash for everyday spending, alleviating short-term pressures, it's important to be aware of the potential impact on your future retirement income.

'Significant reduction' in retirement income

According to a new survey by Aon among 132 defined contribution (DC) pension schemes in the UK, one in five schemes have seen an increase in members reducing or opting out of their regular pension contributions over the last three months.

Steven Leigh, associate partner at Aon, warned that opting out of pension saving for just three years could lead to a significant reduction in retirement income.

"In order to make up this shortfall, savers would have to pay increased contributions each and every year until retirement," Leigh explained.

In the same three-month period, one in six DC schemes saw an increase in requests for early access to pension savings.

"It's not just the savings part of the 'pensions journey' where cost of living challenges may have an impact," Leigh added. "There is a real risk that drawing on pension savings early could result in many employees not being able to afford to retire at the time they had originally planned."

There has also been an increase in members raising concerns or requesting information about investment performance, due to uncertain economic conditions and stock market volatility. In response, almost half (47%) of DC pension schemes have issued additional communications to members and one in four (26%) are considering or already offering additional flexibility for members around contributions, Aon found.

Reducing the effects of market volatility

For savers who are approaching retirement and are concerned about stock market volatility and running out of money in retirement, one option is a blended portfolio combining a fixed term annuity and a smoothed investment fund, says LV=.

As interest rates have risen over the past year, so too have annuity yields. For example, in January 2023 LV='s fixed term annuity yields were 2.5 to 3 percentage points a year higher than in January 2022.

With a blended approach, the fixed-term annuity can be used to cover basic needs and deliver a secure income for a period ranging from 3 to 25 years. Alongside this, investing in a smoothed investment fund offers the potential for lower-volatility growth.

"Blended annuity and drawdown portfolios are a way of balancing the trade-off between controlling a retirement portfolio to benefit from future investment growth while reducing the effects of market volatility," said David Stevens, retirement director at LV=.

Recent interest rate changes and market volatility have highlighted the importance of considering annuities as a way of underpinning a retirement income, Stevens added.

"However, this is not an option a customer can typically navigate on their own. High-quality financial advice is vital when constructing such solutions to ensure each customer is comfortable they have the right balance of risk and flexibility that is right for them in order to enjoy the retirement they want."