Rising interest rates – should I cut my pension and ISA contributions to cope?

As rising interest rates put yet more pressure on household finances, this is having an inevitable knock-on impact on pension and ISA contributions. This article looks at the impact this has on future finances and shows you that whatever you can afford to save right now will make a difference over the long term.

Published on 12 Oct 20226 minute read

The sharp rise in interest rates has come as a shock. Borrowers and investors alike have grown used to an environment of low interest rates and benign inflation over the past decade. The new environment has significant repercussions for household finances. How can you ensure they have resilience over the longer term?

Why are interest rates rising?

Interest rates have been rising steadily for much of this year as the Bank of England tries to calm inflation. Inflationary pressures have come about primarily because of rising food and energy costs in response to the war in Ukraine. However, the disruption to supply chains during the pandemic and increasing demand as economies have reopened have also played a role.

These rate rises were not a surprise, and interest rates were expected to peak at around 4% next year once the worst of the inflationary threat was over and some normality had returned to the economy.

But the UK Government’s mini-budget has changed the landscape once again. In lowering taxes and raising spending, it has stoked fears of higher inflation. The worry is that interest rates will have to rise faster than expected. This has pushed up interest rates in the government bond (gilt) market, which has a direct impact on mortgage rates.

The cost of rising mortgage rates

Higher mortgage rates put pressure on households in a number of ways. The most obvious is through mortgages. Around 35% of UK adults have a mortgage [1]. While around three-quarters of mortgages are currently on fixed rates initially [2], many will find a steep rise in their mortgage costs as their term comes to an end. With current rates as low as 1.5%, repayments may double or more as those fixed rates end. This puts further pressure on household finances, already strained from rising utility bills and food costs.

Time to cut back on saving?

In this environment, people often stop saving into a pension or ISA to preserve cash, particularly when stock markets are volatile. But making cuts today can jeopardise your financial future so if possible, it usually makes sense to avoid doing this. There are a number of reasons why it is important to try to maintain a savings habit even in difficult times. We look at these below.

Small investments can really add up over time

This is thanks to the effect of compounding. Just £50 a month, carefully nurtured over 20 years, growing at 5% a year (net of fees), could give you a pot of over £20,000. That could be an important cushion for the next time things get tough. And if you are investing in the stock market, the more you invest when markets are weaker, the more it can boost your return over the longer term, when markets rise. But remember that investments carry risk and you may get back less than invested.

A break from investing can have a big impact

Taking even relatively short breaks from investment can significantly dent your retirement income. Analysis by life insurer Aegon [3] (based on contributing the minimum auto enrolment amount into a workplace pension scheme) shows that stopping contributions for just one year at age 25 will save you £622 initially but could mean losing £7,300 from your total pension fund at retirement. A five-year break could lose you £42,100 at retirement, while a 10-year break could see you lose almost a quarter of the total fund. The total fund value without a break in contributions is calculated at £398,900 at state pension age.

Remember the benefits of tax relief on pensions

Contributions made into a pension could cost far less than you think because of the tax relief. If you’re investing in a company scheme, you will also get a contribution from your employer. If you’re a basic-rate taxpayer, an £80 contribution becomes £100 with tax relief from the government and then your employer has to contribute at least 3% of your pay on top. For higher-rate taxpayers, the government’s contribution will be 40% or even 45%.

The good news for annuity rates

High interest rates push up annuity rates. From 1 September 2021 to 1 September 2022 annuity rates increased by nearly 50% and they may go higher still if government bond yields continue to rise [4]. While this won’t have any immediate impact for anyone but retirees, it means that retirees can buy a bigger income with a smaller pot. That should provide some reassurance for those who are watching volatility in stock markets nervously.

In tough times, your money has to work hard for you

Our mantra is to keep saving as much as you can – although we recognise this isn’t always easy to do – and to take advantage of tax reliefs and allowances as well as employer contributions on pensions.

The quality of your investments also matters because there are a lot of investments that don’t do very well and these can have a significant impact on the amount of money you’ll have in the future. If you’d rather not choose your own investments, a simple option is to opt for a Ready-made Portfolio. And finally, keep an eye on fees too because they eat away at your investment returns over time.

Would a free Bestinvest coaching session help?

Our Coaches are all qualified financial planners and they’re here to help you with your investments and financial plans. At a free 45-minute coaching session, you’ll get the opportunity to talk through your plans and goals, get an accurate assessment of your investment portfolio and hear helpful insights and tips.

To book a free session, just visit the digital calendar and pick a date and time that suits.

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Important information

This article does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

The value of an investment, and any income from it, may go down as well as up and you may get back less than you originally invested.

Past performance is not a guide to future performance.

Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.