Planning for retirement can be a daunting process, and avoiding common pension mistakes is one of the most important parts of working towards a comfortable retirement.
The majority of people saving for retirement are saving into a defined contribution, or money purchase pension. The amount you receive in retirement from this type of pension depends on how much you contribute, and on how your investments perform.
This means that you need to think particularly carefully about how you manage and access your pension pot. Failing to make the most of your investment options, for example, or being charged too much are a couple of the ways you could be making mistakes that’ll cost you in the long run. You can find out more about defined contribution pensions in our guide What is a defined contribution pension?
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
In this article, we run through the five biggest pension mistakes that people often make – and how to steer clear of them.
1. Drawing your pension too early
You can access your pension from age 55 (rising to 57 in 2028) under current rules, but that doesn’t mean you should start taking money out at this point. You can take up to 25% as a tax-free cash lump from your pot from this age, which might be tempting. However, remember that any money you take from your pension early could potentially miss out on investment returns over the years ahead. Leaving your pension pot untouched for as long as possible will hopefully give your money more time to benefit from tax-free growth, although of course there are no guarantees. Learn more in our guide Should I take a tax-free lump sum from my pension?
If you’re struggling to cover high living costs, see if you can reduce your spending or access other savings rather than dip into your pension. Bear in mind that pensions can be passed on free from inheritance tax (IHT), so you might be considering using other savings to cover spending. Read more about the risks of taking some of your pension early in our article Should I use my pension to boost my income? and about pensions and inheritance tax in our guide Can my pension be used to reduce inheritance tax?
2. Failing to consider tax on pension withdrawals
Any withdrawals over your 25% tax-free cash lump sum are considered part of your income and will therefore be taxed at your marginal rate. This means that the value of your withdrawal will be reduced by the tax you pay, and could potentially also push you into a higher rate tax bracket. Read more in our article How much tax will I pay when I withdraw my pension?
As a result, it’s important to make sure you do your sums and have fully considered the tax implications of any pension withdrawals you may be considering. A financial advisor can help you to decide on a suitable withdrawal rate based on various factors such as your age, lifestyle, and market conditions.
If you withdraw more than your tax-free 25%, you’ll also reduce your Annual Allowance, which is the amount you can contribute to your pension each year and still benefit from tax relief. By taking more than your 25% tax-free lump sum, your allowance will fall from £60,000 to £10,000, and become known as the Money Purchase Annual Allowance (MPAA). If you’re still paying into your pension and hoping to build up your retirement fund, this could be a major disadvantage in the long run. Find out more in our article What is the Money Purchase Annual Allowance?
3. Not saving enough for retirement
Many of us aren’t saving enough for retirement. While many more people are paying into a workplace pension under the government’s auto-enrolment scheme, plenty are only paying the minimum. The minimum amount you must currently pay into a workplace pension is 8%, typically split as 3% from your employer and 5% from you. Unfortunately, without other savings in place, this is unlikely to be sufficient for a comfortable retirement. Read more about auto-enrolment in our article How does pension auto-enrolment work?
According to the Pensions and Lifetime Savings Association (PLSA), for example, to achieve a moderate standard of living in retirement, a couple sharing costs and each receiving the new full State Pension (about £10,600 in 2023/24, rising to £221.20 a week or £11,502.40 a year in the 2024/25 tax year.) would need an income of around £43,100 a year. To provide this, a couple would need to build up a joint retirement pot of £459,000, based on them using a flexible income drawdown plan to provide their retirement income, on top of their State Pension. Read more in our articles How much should I save for retirement? and Can you afford to retire?
It’s not always easy to increase the amount you’re saving, particularly when living costs are rising. However, there are simple ways to top up your pension that you might not have thought of, such as increasing your workplace pension contributions, or topping up your State Pension. If you’re an employee, see if your company will pay more into your pension, or start paying into a private pension if you’re self-employed. You can read more about these in our article 11 simple ways to top up your pension.
4. Paying too much in charges
Knowing how much you are paying in pension charges is an important part of retirement planning, as the amount you pay can make a huge difference to the eventual size of your pension pot. Charges typically cover the cost of your provider managing and administering your pension, and investing your contributions into the stock market.
There is a cap of 0.75% on annual management charges for workplace defined contribution pensions under auto-enrolment rules. However, if your pension was in place prior to the introduction of auto-enrolment in 2012, the charging cap doesn’t apply. Typically, the older your pension scheme, the higher the annual management charge will be, with fees that in some cases can amount to as much as 2% of your pension’s value each year. Read more in our article What pension charges am I paying?
Annual management charges for pension schemes have been falling over recent years, since the introduction of the charging cap. These days, annual charges of 1-2% are considered expensive, so if you’re paying this amount, it may be worth considering moving your pension to a cheaper plan.
Over 15 years, opting for the cheapest Sipp provider could save someone with a £250,000 pot almost £22,000 in fees, according to consumer organisation Which?. This is a huge amount when you’re trying to make your money go as far as possible in retirement. However, transferring pensions is not without risk, so you should seek advice before proceeding. Find out more in our guide Should I transfer my pension?
5. Sticking to your workplace ‘default’ pension fund
Many pension savers find that their contributions into their workplace pension scheme are automatically invested into a standard ‘default fund’ unless they’ve chosen a different option.
This will usually invest in a mixture of assets, with the investment approach changing as you approach retirement. For example, you may find you’re mainly invested primarily in shares if you’re a decade or more away from retirement, but a greater proportion of your pot will shift into lower risk investments such as bonds or cash as you approach retirement age to reduce your investment risk. Find out more in our article Where is my pension invested?
However, your workplace default fund may not necessarily be the best option for you, depending on your attitude to risk, age, and retirement plans. You may be comfortable taking more risk, particularly if you’re some way off retiring. Besides, many people plan to stay invested into retirement in a drawdown plan so are willing to continue accepting a level of risk in the hope they’ll end up with a higher retirement income. Read more in our article Five questions to ask about your workplace pension.
Where to seek advice
Ensuring that you’re on track for a comfortable retirement can be a challenging process. It’s important to seek financial advice and learn about the mistakes and risks involved when you’re managing and withdrawing your pension.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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