Most of us spend the majority of our working life saving into our pension. However, all this hard work saving can quickly unravel for those who aren’t aware of common pension mistakes.
WEALTH at work outlines below the top 10 pension mistakes individuals could make, to highlight what employees facing retirement may need support with.
1. Withdrawing savings from a pension early
As a result of the rising cost of living, one in 10 (10%) over 55s in full-time employment have withdrawn pension savings earlier than previously intended to supplement their income, yet 31% say they intend to or may consider it in the future, according to a survey from WEALTH at work[1].
Withdrawing money out of a pension earlier than planned really should be a last resort and individuals must understand the dramatic impact this can have on retirement savings, which could include either having to work longer or having less income in retirement.
2. Not understanding how pensions are invested
When it comes to pensions, individuals may not understand that pensions are often invested in ‘lifestyle funds’ which typically move investments out of higher risk funds such as equities, into lower risk funds including bonds and cash, as people approach their chosen retirement age. This made sense when the majority bought annuities, as they didn’t want to risk a market crash’s impact on their savings just before retirement. However, many people now access their pensions using income drawdown[2], meaning that it generally may be better for their pensions to stay invested in equities long into retirement, to give their money the potential to keep growing. Individuals should speak to their pension provider to find out what investment path they are on, and if it is aligned with their retirement income plan.
3. Missing out on lost or forgotten pensions
The total value of lost pension pots has grown from £19.4 billion in 2018 to £26.6 billion in 2022[3]. Some of the main reasons this occurs can be moving jobs, or people moving house and not updating their address with their pension provider.
If someone has a lot of different pensions, they may want to consider consolidating them into one pension pot, especially as they may all have different investment strategies. It can also make it easier for them to manage their finances and could save them money on the fees charged. However, it is important to ensure there aren’t any enhanced features or protections that could be lost by transferring, and that the scheme chosen provides the flexibility required for when accessing the money in retirement.
4. Not shopping around
Many people are choosing to use income drawdown instead of an annuity. However, it’s crucial that people shop around to make sure they are getting the best deal. In a 2022 investigation, Which?[4] found that the difference in growth between the cheapest and most expensive drawdown plans for a £260,000 pot was nearly £18,000 over a 20-year period.
5. Withdrawing cash to put in the bank
Some people are taking money from their pension just to put into their bank account or other savings and investments, but they may not be aware that by doing this their money could lose value over time, as returns on savings accounts typically don’t keep pace with inflation. They will also lose out on the valuable tax benefits available in the pension scheme. It’s usually better to leave the money invested in a pension fund where it keeps its tax-free status, and only withdrawing when it is actually needed.
For example, if someone took £20,000 from their pension, they could receive the first £5,000 (25%) tax-free. The remaining amount would then be taxed as earned income, which for a basic rate tax-payer would mean a tax charge of £3,000, leaving them with £17,000 net of tax. If this was then deposited in a savings account, they would then only be receiving interest on this lower sum (£17,000 rather than £20,000) and the money would also form part of their estate for inheritance tax purposes.