5 common pension mistakes, and how to avoid them as you approach retirement

Category: News & United Kingdom

It’s very possible that you’ve done a lot of the hard work saving for your retirement already.

You may have made regular contributions to your pension fund, diligently saving throughout your working life.

In doing so, you’ll likely have taken full advantage of the tax efficiency on offer, building up a sizeable retirement fund that’ll mean you can enjoy a good quality of life when you retire.

But as you move closer to your planned retirement date, it’s easy for you to make simple mistakes with your pension funds that could cost you money and interfere with your wider retirement plans.

Discover five common pension mistakes, and how you can easily avoid them and secure your wealth for the future.

1. Paying too much tax on your retirement income

Since the introduction of UK Pension Freedoms legislation in 2015, you can start drawing money from your UK pension when you reach the normal minimum pension age. In 2023/24 this is 55, and is set to rise to 57 in 2028.

These rule changes also included the ability to take the first 25% of your fund free from Income Tax. You can take this in a single tax-free lump sum, or take multiple amounts where 25% of each sum is free from tax.

This flexibility can be seen as a positive when it comes to putting together your retirement income strategy, but it can also raise some potentially serious issues.

One of the most important of these is that, apart from your tax-free entitlement, all money you take from your pension is treated as income, and taxed accordingly at your marginal rate.

This means that you need to plan your retirement income strategy carefully. Always be aware of Income Tax thresholds, because if you aren’t careful you could end up paying more tax on your pension withdrawals than you need to.

2. Using your pension fund for non-retirement purposes

A second mistake associated with the flexibility gained from Pension Freedoms is to see your pension fund in the same way as you see other savings. This can easily result in you taking money from your retirement fund for non-retirement goals before you’ve even stopped working.

For example, this might be to pay off your mortgage or gift money to your family. However, just because you can currently access your fund from age 55, it doesn’t mean that you have to.

Unless you’re taking it from your 25% tax-free entitlement, you’ll pay Income Tax on your pension withdrawals. If you’re still working and contributing to your pension, you may also be subject to the Money Purchase Annual Allowance (MPAA). This can reduce the maximum annual amount you can pay into your fund while receiving tax relief going forward, down from £60,000 to just £10,000.

You may also want to avoid moving this lump sum elsewhere – maybe to a savings or investment account – even if you aren’t planning to use it. By doing this, you’re potentially making it subject to Inheritance Tax (IHT) when you die. Most pension funds are exempt from IHT and will not be taken into account when the value of your estate is assessed.

Carefully consider these aspects before you start drawing money for reasons other than funding your lifestyle in retirement.

3. Following the wrong investment strategy

As you have built your retirement fund, you may have taken advantage of the benefits of compounding returns over time, as your pension funds will likely have been invested.

However, as you get close to retirement, it’s important to review how your fund is invested and ensure you’re still comfortable with the level of risk you’re taking.

Unless you plan to use your entire fund to buy an annuity, which will provide you with an income for the rest of your life, your pension fund will typically remain invested.

As a result, it may be worth checking that you are still pursuing an appropriate investment strategy that takes sufficient risk to grow your pot in retirement but avoids excessive volatility and the potential for losses.

This can be particularly important at retirement, as you may be able to tolerate fewer fluctuations in the value of your funds if you’re starting to draw on them.

4. Not appreciating how long your retirement fund will need to last

According to the Office for National Statistics life expectancy calculator, a man currently age 60 has an average life expectancy of 84. For a woman of the same age, the equivalent expectancy is 87.

However, the man has a 25% chance of living to age 92 and the woman has the same chance of living to age 94.

This means that if you are in good health, there’s a decent chance that your retirement could last for 30 years or even longer.

As a result, the longer you’re able to leave money invested in your pension and continue to pay into it, the longer these funds will likely last. In turn, this can ensure that you’ll have enough to fund your entire retirement.

You may also want to consider your potential longevity when deciding on your income strategy. For example, it’s likely that you will want to draw more income from your fund in the early stages of your retirement, as you’re more active and want to tick items off your bucket list.

That said, you may reduce your discretionary spending later in your retirement, as you may need to cover care costs later down the line. These are important considerations to factor in.

5. Overlooking the effect of inflation on your retirement income

As well as considering what your income requirements may be during the different phases of your retirement, it may also be worth bearing in mind that the amount of income you’ll need will likely rise each year, even if what you do in those years doesn’t change.

This is because inflation – that is, the increasing cost of goods and services over time – can affect how much your money will be worth in real terms. Over the long term, increasing prices can have a significant impact on how far your retirement income will go.

This becomes an even more important consideration if you bear in mind that you likely won’t be earning an income or adding any more savings to your fund.

Get in touch

If you have any queries regarding planning your income in retirement, please get in touch with us.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

This article is for information only. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances. All contents are based on our understanding of HMRC, which is subject to change.