Pension pots and retirement savings are often the most money many employees will ever have access to, so it is important that those retiring in 2022 understand their options and make informed decisions. Many of the mistakes employees make with their hard-earned savings could have been easily avoided.
To help, WEALTH at work, a leading financial wellbeing and retirement specialist, has created a list of top 10 tips for those employees who are thinking about retiring in 2022.
1. Estimate how much will be needed in retirement – Employees should consider how much income they will need in retirement including essential income to meet their day-to-day living expenses (household bills etc) and discretionary expenditure (holidays and hobbies etc). Don’t forget that in retirement, individuals will likely pay less income tax, no National Insurance (NI), mortgages and loans may be paid off, they won’t have any pension contributions, and any children are likely to be financially independent. With these reductions in costs, the income needed in retirement is likely to be significantly less than that of what’s required during someone’s working life.
Recent research from The Pensions and Lifetime Savings Association (PLSA)[1] found that a single person now needs a post-tax annual income of £10,900 for a minimum standard of living in retirement (this would cover all a retiree’s needs plus enough for some leisure activities such as a week’s holiday in the UK and eating out occasionally); £20,800 for a moderate standard of living (a two-week holiday in Europe and more frequent eating out); and £33,600 for a comfortable standard of living (this would cover all a retiree’s needs plus enough for some leisure activities such as a week’s holiday in the UK and eating out occasionally). A couple would need £16,700, £30,600 and £49,700 respectively.
2. Check if retirement is affordable – Employees should check if they have enough put aside to be able to afford to retire, or maybe they will need to work a little longer, or perhaps work part-time. Research has found that most people live longer than they expect, so this should be kept in mind when doing any sums. The Office for National Statistics (ONS)[2] estimates that life expectancy in the UK for people aged 65 will be 85 years for men and 87 years for women.
3. Pensions are not the only source of income – When it comes to retirement, there are many assets such as ISAs, shares and general savings, which can be used as potential sources of income in addition to any pensions. It is a good idea for employees to work out which assets they have, what they are all worth, and the best way to use them to make sure they are not paying unnecessary tax.
4. Don’t pay unnecessary tax – Usually only the first 25% of a defined contribution (DC) pension is tax free (the calculation for a defined benefit scheme will be different); the remaining 75% is taxed as earned income. Unfortunately, in recent years many employees have found themselves paying more tax than they need to. For example, some have taken their pension as a cash lump sum, not realising that it made them a higher rate tax payer! An individual may be better off taking a smaller amount each year from their pension, keeping within their tax bracket, and then to top it up with withdrawals from their ISA, as this is paid tax free.
5. Decide how to access pension income – If an employee has a DC pension, they can access their savings from age 55 and will need to decide whether they want to do this through income drawdown, buying an annuity, taking it as a cash lump sum, or a combination of these options.
If an employee has a defined benefit (DB) pension, their pension income is usually based on a rate set by the scheme (the accrual rate) and typically is a percentage or fraction of their salary for each year they have been an active member of the scheme. A DB pension usually has a set retirement age which could, for example, be on their 60th or 65th birthday; however, they may be able to receive benefits earlier or later than this. Some people may want to transfer their DB pensions into a DC pension fund so that they can have greater flexibility over their savings. However, it is important that employees understand the advantages and disadvantages of this first, as well as the associated risks such as falling for a scam, buying inappropriate retirement products, paying more tax than necessary and ultimately running out of money.
Employees will need help to understand their options, and which might be the best for them. They could speak to MoneyHelper for guidance about their DC pension options. Many companies also offer their employees financial education and guidance to help them understand their options at retirement.
6. Shop around – Employees should make sure that they shop around before purchasing any retirement products. Which?[3] found that the difference between the cheapest and most expensive income drawdown plan for a £250,000 pot was £12,300 lost in charges over a 20 year period. It is important to not only check fees, but make sure it suits an individual’s needs, and that they can withdraw cash as and when they want it, and for as long as they need it.
7. Keep pension beneficiary details up-to-date – Pensions can be a very tax efficient way to pass on wealth upon death and are not usually subject to inheritance tax. When a DC the pension holder dies, the pension provider chooses who receives the pension pot. You can inform the provider of your wishes by nominating beneficiaries, so it is important that employees review and keep these details up to date. If someone was to die before the age of 75, the person who inherits their pension pot can draw on the money as they wish, without paying any income tax either. However, if someone is 75 or over when they die, a beneficiary of their pension pot will have to pay income tax on any withdrawals at their marginal rate (i.e. the highest rate of income tax that they pay). This means that any remaining pension can pass onto beneficiaries’ tax free; subject to not exceeding the current £1,073,100 lifetime allowance, and providing that the company pays out within two years of the date of death.
If someone’s beneficiary is entitled to continue receiving payments from an annuity or defined benefit pension after death, then these payments will be subject to income tax at their marginal rate.
8. Regulated financial advice can support employees through retirement – The FCA[4] found that only 10% of pensions were accessed to purchase an annuity in 2020/21. Increasing numbers are accessing their pension through income drawdown. However, Pensions Policy Institute (PPI) research[5] has found that cognitive decline over retirement may make it more difficult for some people to make appropriate decisions about how to access their savings in their older years.
Employees need to realise that regulated financial advice can be a solution to this and may actually cost the same, if not less than buying retirement products, such as annuities, through some online brokers. It can also be seen as an investment as an Adviser will look at an individual’s assets, work out the most tax efficient way for them to fund their retirement and then put a bespoke plan in place for them, which will support them throughout retirement.
9. Beware of scams – Scammers often use highly professional looking websites and marketing literature to lure employees in, and tend to sound completely legitimate when they make contact. It’s easy to see why so many people are fooled, and it isn’t small amounts of money which are being taken. Between January and May 2021, pension scam losses totalling over £2.2 million were reported to Action Fraud.
New regulations came into force in November which means suspicious transfers can be stopped from ending up in the hands of a fraudster, as pension trustees and scheme managers now have new powers to intervene, but employees still need to be on their guard. Whatever they’re planning to do with their retirement savings, it’s vital they check whether the company that they’re planning to use is registered with the Financial Conduct Authority (FCA) https://register.fca.org.uk/. They can also visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams www.fca.org.uk/scamsmart.
10. Make an informed decision – The ability to access pension income in a way which works for someone is a great option to have, but it is also a frightening or overwhelming prospect for many. It is vital that employees make sure that they fully understand all of their options, to choose what is right for them and best suit their needs.
Jonathan Watts-Lay, Director at WEALTH at work, comments; “We spend many years saving for our retirement and it is heart-breaking when employees make mistakes with their hard-earned savings which could have been so easily avoided.”
Watts-Lay concludes; “Many employers with retiring employees, now offer access to financial education, guidance and even regulated financial advice which can lead to better outcomes for all.”
[1] PLSA research
[2] ONS Life expectancy calculator
[3] Which?
[4] FCA
[5] Pensions Policy Institute (PPI)