Matthew Wall, Tuesday April 08, 2008

Savers are slashing their pension contributions as the credit crunch takes its toll on household finances - but what could be the damage in future? We take a look - and show you how to preserve your pension pot

The credit crunch and the rising cost of living have caused UK workers to drastically reduce their voluntary contributions to work and private pensions.

The Prudential 2008 Retirement Savings Report has found that UK adults are contributing an average of just £144.57 a month, or less than £1,800 a year. Last year's report found that this monthly figure was £279.38.

Even households with above average incomes are struggling to cope with the increasingly tight financial conditions. Nearly three quarters of households with a total income of at least £30,000 plan to cut back their spending this year, reports insurance giant AXA. In addition, around one in five high earners will either stop saving or reduce pension contributions in a bid to boost finances.

In recent years, relatively affluent households have been lulled into a false sense of security because of rising house prices. Property effectively became the new pension. However, with house prices falling and borrowing becoming more expensive, the old investment maxim of not putting all your eggs in one basket is more relevant than ever.

Worryingly, 55% of non-retired UK adults claim that they do not contribute to a private or company pension scheme at all. Those that do are seriously underestimating the amount they need to contribute each month to achieve the level of retirement income they want and expect.

Great expectations
Many expect to receive an annual pension of £22,504 a year in retirement, but a 20-year-old man would have to save £286 per month until the age of 65 to achieve this figure, state Prudential. Comparatively, a 20-year old woman would have to save £413 per month until the age of 60.

Furthermore, those who delay starting a pension are often oblivious to the future problems this may cause. According to Pension Calculator, a 20-year-old woman contributing £200 a month can expect to receive an annual pension of around £12,000 in today's prices if she retired at 65 (taking into account the effect of inflation). If she waited until the age of 40 before starting a pension she would have to contribute £525 a month to achieve the same figure.

The nine million people who have a 'final salary' or 'defined benefit' pension scheme through work are the lucky ones and in the best position to emerge relatively unscathed from the current financial storm. This lies in the fact that these pensions are related to how much the individual was earning when they left or retired and are not so directly affected by the performance of the stock market.

Savers with 'money-purchase' schemes, either organised through work or taken out as personal pensions, are in a trickier situation. For the size of their pension is dependent on the performance of the stock market. Younger people (generally those under 40) have sufficient time to smooth out the ups and downs of stock market performance, but older people nearing retirement are much more vulnerable to a downturn if their pension pots are still invested heavily in equities.

Fortunately, most personal pensions offered by large insurance companies include a 'lifestyle' option that automatically switches pension money into less risky investments such as cash, bonds and gilts as retirement grows closer. It is worth checking whether this type of personal pension has such an option, otherwise the pension pot can be significantly reduced after a stock market crash.

If a pension doesn't have this option, there is no need to panic and sell equities to buy safer investments. This will only crystallise losses when there may still be enough time for the investments to recover before retirement. Bear in mind that when shares are at bargain basement prices, monthly pension contributions will go much further and help to smooth out market volatility over time.

The main message when it comes to pensions is that doing something is better than nothing. Otherwise, tins of 'value' baked beans may be the staple diet during retirement.