Recent figures revealed that in the year to the end of March 2019, almost half of all pension pots were accessed without the holder taking any regulated advice. The data also showed that over 350,000 pension pots were fully withdrawn at the first time of access.
The new rules have given 600,000 people the flexibility to take money from their pension savings in the last year. However, there is a huge concern that retirees taking their savings without advice are making one of two pension mistakes:
- Putting themselves at risk of running out of cash in later life
- Paying too much tax
Taking your pension pot without advice could lead to you making the wrong decisions. So, with 31 October just around the corner, here are seven scary pension mistakes you should avoid making this Halloween.
1. Drawing your pension too early
Since the changes to pension rules in 2015, you can now access your pension savings from age 55. This has meant that some people choose to take an income from it while they are still working.
Depending on your situation, it can be better for you to leave the money invested until you retire as it has more time to accumulate.
Leaving your pension invested may also have tax benefits. If you have a salary of £25,000, you’ll pay Income Tax at 20%. If you decided to take an annual pension income of £15,000 on top of your ‘employed’ income, all this amount would be taxable, and you’d end up paying £3,000 in tax.
If you waited until you had stopped working and then decided to take your pension income (assuming you had no other income), most of your £15,000 pension would be covered by the tax-free Personal Allowance (currently £12,500). In this instance, you’d only pay £500 in tax.
2. Taking all your cash in one go
More than 350,000 pension pots were withdrawn in full in the year to 31 March 2019.
While the current rules allow you to take your savings as cash, anything you withdraw above the 25% tax-free allowance is added to your income for that year and taxed accordingly.
If you earned £40,000 a year, you’d pay basic rate tax of 20%. If you cashed in a pension pot of £40,000, you could take £10,000 tax-free, and then the £30,000 would be added to your income for that year and you’d be taxed on this at the higher rate of 40%.
With the higher rate tax threshold set at £50,000 this year, you would have £20,000 of your income taxed at the higher rate.
All this means that you may be better withdrawing your pension savings in stages to avoid being pushed into a higher tax bracket.
3. Not shopping around for the best deal
According to the Financial Conduct Authority, 94% of people entering pension drawdown fail to shop around for the best deal.
An overwhelming majority of people who are keeping their pension invested while drawing a regular income stay with the company that managed their pension savings. This means that thousands of people are missing out on lower charges and a wider range of drawdown options and investments.
In a 2018 investigation, consumer group Which? found that the difference between the cheapest and most expensive drawdown plans was a staggering £12,000 lost in charges over a 15-year period.
So, like many other financial products, it’s vital that you shop around for the best value drawdown. If you don’t, you could end up paying more in fees and charges than is necessary.
4. Investing your pension savings in cash
While it can be prudent to hold some of your pension savings in cash, it should rarely form a large part of your portfolio.
Figures in The Times show that if you held £100,000 in a cash account paying 0.5% interest for ten years and inflation ran at 2% during that period, your fund would be worth about £86,000 in real terms at the end of the decade.
While the value of stocks and shares can go down as well as up, most experts suggest a diversified strategy where your investment is held in different stocks and bonds from around the world. This may also include an element of cash.
5. Using your pension pot when you have other options
Figures from the Department for Work and Pensions show that around 30% of the income of a pensioner couple comes from sources other than pensions. This can include investment income and income from employment or self-employment.
If you do have access to other income when you retire, it can be better to start by using these other sources to fund your lifestyle, rather than raiding your pension pot immediately. This is because your drawdown fund is growing free of both Income and Capital Gains Tax.
Additionally, pension funds are free of Inheritance Tax and therefore represent a good way to pass on assets to the next generation.
6. Withdrawing money if you don’t need it
Do you really need to take money from your pension savings? As we saw above, the money that you have invested is growing free of both Income and Capital Gains Tax, so if you don’t immediately need it then it can pay to leave it alone. As we noted above, pension funds are also free of Inheritance Tax.
Withdrawing money can lead to:
- Losing tax breaks and, in some cases, paying tax
- Losing investment returns and, instead, investing in somewhere where the returns are lower.
7. Blowing your savings
According to the OECD, the average 65-year old man in the UK will live for another 18.8 years, while the average 65-year-old woman will live for another 21.1 years.
So, many people will need their pension pot to last them throughout retirement, which could be two decades or more. One of the big pension mistakes you can make is spending your savings much too quickly, leaving you short of cash in later life.
Even if you receive the full State Pension – currently £168.60 per week – you’ll need to make sure that your pension savings last you for a lifetime.
Get in touch
Taking advice on retirement can help you to keep control of your income and your lifestyle. So, if you’re approaching retirement and you need professional advice on how to structure your retirement, get in touch. Email firstname.lastname@example.org or call us on 01189 876655.