10 Costly Pension Mistakes that millions of Britons make
We all make mistakes in life and pensions are no exception. The only difference is pension mistakes can be much more costly than others. Why? Because people who are now 65 years old are expected to live off their pension for another 21-24 years. One in three babies born in 2013 will live to the age of 100.
The younger someone is today and the longer they are expected to live, the more pension mistakes could cost.
1) Not Saving Enough
Millions of people face a ‘bleak old age’ – said Lord McFall, chair of the Workplace Retirement Commission. More than 4 in 10 working age people don’t know when they will be able to retire and more than 1 in 10 expect to never be able to afford to fully retire.
In reality 66% of retirees see their income fall in retirement compared to their working life and 21% see it fall by more than half.
How can an investor tell if their pension is on track? A pension calculator could be a good place to start. It shows the retirement income that could be received and effect of inflation, charges and returns can have.
2) Delaying Saving
The longer an investor delays, the more it costs to build a good sized pension. This is because of ‘compound interest’, which Albert Einstein called “the most powerful force in the universe”.
3) Not Checking The Pension Pot
Relatively few people review their pension let alone know the value of their investments.
Not all investments are the same. Even a seemingly small difference in performance could have a significant impact on the size of the pot.
A 35 yr old with a £20,000 pension pot could have a fund worth £26,871 at age 65 if their investments grew by 2% a year. The fund might be worth £64,115 at 65 if their investments grew by 5% a year or £149,277 if they grew by 8% a year (assuming in all cases an annual fund management fee of 1%). These are just projections. Investments will not always go up in value, they can also go down, so an investor could get back less than they invested. Also these values do not account for inflation, which will reduce the spending power of money over time.
4) Not Checking The Charges
Most people know how much they pay for their mobile phone, but not for their pension! Nor do they know what they are paying for.
Pension charges typically buy the services of the pension provider and the expertise of a fund manager who looks after the investments. In addition, some people employ a financial adviser to make recommendations. The charge for this advice is usually paid separately.
The services received from a pension provider vary in depth and quality. Things that might (or might not) be included:
- Efficient administration
- Good customer service
- A UK based helpline
- Quick response times for instructions and enquiries
- Online access to pension
- Online planning tools including calculators and portfolio analysis
- Clear, concise information
- Pension and investment research
5) Relying On Property
Your home may be your largest investment. If an investor decides to just use property as a retirement fund, they could be putting all their eggs in one basket.
Investment professionals agree diversification is key to managing risk, although it doesn’t guarantee an investor won’t make a loss. So, if an investor already has capital invested in property, it could make sense for them to consider diversifying and investing in different asset classes. See also our post Diversify Your Investments.
6) Relying On Inheritance
People sometimes rely on inheritance to fund their retirement but could then find their plans are resting on shaky foundations.
Why is that? Common sense highlights the first problem with inheritance: an investor can never be sure when they’ll receive a windfall. The way life expectancy is shaping up, older generations are likely to live well into their retirement years.
The amount inherited could also be far less than expected.
7) Not Taking Up Employer Contributions
Companies, especially the larger ones, usually offer workplace pensions. The good news is that by 2018 all UK companies, irrespective of size, will have to offer a pension to their employees and contribute to it on their behalf. The bad news is some private sector workers aren’t currently saving into a workplace pension. This means they could be missing out on ‘free money’. Many more are just contributing the minimum. Whilst this is a step in the right direction, it’s unlikely to be enough.
8) Assuming The State Will Provide
In 2013, one in seven retirees relied exclusively on the State Pension for their income. For 2015/2016 the state guarantees a minimum income of £151 a week for those who have reached State Pension age. From April 2016, the complex system of basic State Pension, additional State Pension and means-tested benefits will be replaced with a single-tier State Pension of the same amount (in today’s money).
9) Not Using Pensions To Save Tax
Tax relief on pension contributions is one of those rare occasions when the taxman gives you something back.
Under current rules when an investor pays money into a pension, the government effectively pays 20% of the total contribution (subject to maximum limits).
10) Not Shopping Around At Retirement
Even if an investor manages to avoid these mistakes, there are further traps to watch out for when they retire.
Rules have recently been changed giving more choice and flexibility. Investors should explore all the options to make sure they choose the right option for them.
From age 55 (age 57 from 2028), up to 25% of a pension can normally be taken as a tax-free lump sum. After that, there are two main ways to draw a taxable income.
The first option is buying an annuity from an insurance company, which provides a secure retirement income for the rest of your life. If you choose this, you should shop around as rates can vary significantly.
There are over 1,500 medical and lifestyle conditions that could help you increase your annuity income. You don’t have to be seriously ill to qualify, you just need to request an ‘enhanced annuity’ – you could get thousands of pounds more every year for the rest of your life.
The second option is income drawdown. Your pension remains invested and you draw an income from it. It is more flexible – but the income is not guaranteed, so it is riskier.
With the changes in pension rules introduced in 2015, investors now have complete freedom over their pension: it will be possible to take unlimited withdrawals from your pension, even the whole fund as a lump sum.
Whichever option you go for, we strongly recommend that you get independent professional financial advice before committing yourself to a course of action.