Avoid these 10 potential pension slip ups

1. Cashing in pensions ‘just because you can’

Whoever said: ‘A bird in the hand is worth two in the bush’ obviously wasn’t familiar with current pension legislation and the benefits the pension ‘wrapper’ offers your hard-earned cash. In addition to facing a large tax bill when you make your withdrawal, you also lose valuable protection from inheritance and income tax further down the line.

This means it only makes sense to take money out of your pension if you have a genuine need for it, and if it isn’t available from other sources such as Isas (where withdrawals won’t be taxed).

However, according to research from Royal London, 23% of customers cashing in pensions have done so just to move the money into a savings account. Fiona Tait, pension specialist at Royal London, says only the first 25% of every withdrawal is paid tax-free.

“The other 75% is subject to income tax so if you take your money out of one investment just to move it into another, you need to be confident your gain will cover your tax bill,” she explains. “Even if you are worried about investing, you can still hold it in cash within your pension.”

If you feel you can make your money work harder, you can still access investment funds and shares within a self-invested personal pension (Sipp).


2. Ignoring guaranteed annuity rates

During the 1980s, personal pensions often offered guaranteed annuity rates (GARs), which were priced at a time when interest rates were so much higher than today. However, according to research from the Financial Conduct Authority (FCA), some 68% of guaranteed annuity rates are not being taken up, rising to 79% for pots worth less than £30,000.

Even on small pots that you might be otherwise tempted to cash in, GARs can be too good to ignore, as Claire Walsh, head of advice at Unbiased, explains: “I had a client with a pot worth £17,000. It had a guarantee of 11% on it, giving him £1,800 a year – it doubled his money in terms of what he would have been able to get with a standard annuity.”

The downside to GARs is that they are not usually very flexible –you may have to start taking the income on a specified date or not get a spouse’s benefit, but you need to be aware of the income that is on the table before dismissing
it altogether.

3. Not shopping around for an annuity

Despite industry-wide attempts to make retirees aware of their ‘open market option’, the number of retirees who are shopping around for guaranteed income is falling, not rising. According to the latest figures from the FCA, 64% of purchasers bought their annuity directly from their pension provider.

Andrew Tully, pensions technical director at Retirement Advantage, says: “People trust the pension company they have saved with to provide the best deal. However, even the financial regulator has recognised that most people can get a better deal by shopping around.”

Figures from Retirement Advantage show that a healthy individual buying the worst deal could miss out on as much as £7,780 in lost income over a typical 20-year retirement (based on the average £53,000 annuity). You can shop around for annuities on comparison websites and with annuity brokers. Alternatively, you can consult a financial adviser.

4. Not telling your annuity provider about health problems

Smoking, being overweight or having medical conditions often mean you pay more for products like life insurance, but when it comes to annuities they count in your favour. This is because you’re likely to have a lower life expectancy and, as such, specialist annuity providers are able to pay you a higher income.

Mr Tully says: “Some people don’t think they should tell their adviser or pension company about a health problem or a long-standing condition, for example high blood pressure. What might seem like a personal question about your health can have a significant and positive effect on the annuity income you could receive. Some companies even employ specialist advisers who are trained to ask the right questions in a caring and sensitive way to try to give you the best deal possible.”

The differences in rates may seem small at outset but, again, they rack up over the years. Retirement Advantage’s figures show that a less healthy retiree with a pot worth £53,000 could miss out on £15,040 over 20 years by not getting an enhanced annuity.

Specialist annuity providers estimate that between 60% to 70% of retirees would be eligible for an enhancement of some kind. However, most pension companies don’t offer enhanced annuities, so you are only likely to come across these specialist providers if you shop around.


5. Don’t assume you’ll get the full state pension

The new state pension (introduced this April) pays a headline rate of £155.65 a week, but while some 10 million savers will be better off with the new scheme (most notably the self-employed and women), double that number will be worse off. Indeed, government figures show that just 37% of the 400,000 people retiring in the coming tax year will be entitled to the full amount.

“People assume they will get it because they have paid into the system for 35 years,” says Alan Higham, founder of pension information site Pensionchamp.com, “and they are coming to me because they don’t understand why.”

The reason is that the new scheme isn’t simply a new, bigger state pension, rather it combines the old basic and additional state pension. This means those savers who contracted out of the additional state pension at any point in their working life – in return for lower national insurance contributions – won’t be entitled to this element in the new scheme.

However, just because you are not eligible for the headline rate, it doesn’t necessarily mean you will be worse off, as all those national insurance rebates should have been redirected into your private pension. In order to work out how much you will have to live on in retirement, it’s important you know what you’ll get from the state. Once you are 55, you can get an accurate state pension statement at Gov.uk/state-pension-statement.


What value can advice add to your decisions?

Cutting your tax bill
Sarah Jones is 56 and has no plans to retire, she earns £90,000 a year and has £400,000 in a pension. She’d like to give her daughter £50,000.

Without advice: Sarah will get £12,500 tax-free (25% of her withdrawal) but the remaining £37,500 will be taxed, giving her a tax bill of £19,240 and reducing the value of her £50,000 withdrawal to £30,760. Under new rules to prevent people from investing their savings to gain a tax advantage, the amount she can pay into her pension will fall from £40,000 a year to just £10,000.

With advice: Sarah splits her pension into two £200,000 pots. She leaves one alone and takes 25% tax free cash out of the other. The remaining £150,000 goes into drawdown but is left untouched. Sarah pays no tax and can continue to save up to £40,000 into her pension each year.

Source: NFU Mutual

6. Don’t underestimate your life expectancy

With an annuity, your income will be guaranteed for life – so even if you live until you’re 110, you can be sure that you will always be able to pay the bills. But if you decide to take advantage of the pension freedoms and manage your savings more flexibly, you will need to give serious consideration to your anticipated life expectancy to ensure you don’t outlive your savings. Unfortunately, this is not something we are very good at.

Alistair McQueen, savings and retirement manager at Aviva, says: “People tend to be influenced by their parents and how long they lived but that makes no sense as life expectancy is continually improving.”

He adds: “Men typically think they will live until they are 80, while women expect to die at 84, but hard analysis shows that if they are healthy a man is likely to live until they are 88, while women can expect to hit 89.”

There are a variety of life expectancy calculators online to give you some guidance, but on top of the fact that they will not be able to accurately predict your years on Earth, they may also just be based on UK averages. “There is a plus or minus five-year difference in life expectancy depending on where you live in the UK,” Mr McQueen explains, “so someone on the west coast of Scotland is likely to live five years less than someone in south-east England.”

7. Track down old pensions

Today’s workers can expect to have an average of nine jobs over their working life, so it’s easy to see how you might forget about schemes you paid into early on in your career, or were only a member of for a short period of time. Some people are also unaware of their rights regarding former pension schemes too, with worrying research from LV= showing that one in 10 people think they will lose their pension when they leave their employer.

According to LV=, there is currently more than £3 billion in lost pensions. The good news is that if you think you’ve got a plan that’s gone AWOL, you can track it down using the government’s Pension Tracing Service (Gov.uk/find-lost-pension). It will not be able to tell you the value of your pension, but it will be able to give you the contact details of schemes you are a member of, allowing you to be reunited with your money.

8. Don’t assume your situation will stay the same

You may be entering your golden years, but that doesn’t mean you are at death’s door. As life expectancy continues to rise, there is every chance you will live for another 20, 30, maybe even 40 years, and a lot can happen in that time.

While divorce rates might be falling across the board, the number of ‘silver-splitters’ is on the rise, with the number of men over the age of 60 getting divorced rising by 73% between 1991 and 2011, according to the Office for National Statistics.

Miss Tait says: “When you are on your own, you may have less support and may find it more difficult to get by financially.”

Health problems may also disrupt your retirement plans – you may end up needing to retire early to care for a sick relative, or find your own health deteriorates and that you need to pay for care as you get older. On the other hand, it may just be that a child moves to Australia and you need to set aside more money for long-haul flights. Whatever your retirement holds in store, it pays to maintain some flexibility so that your financial plan can change as your circumstances do.

9. Ignore inflation at your peril

While you may have the money to pay your bills when you first retire, if you don’t factor the rising cost of living into your budget, you may struggle in the years to come.

“The CPI measure for inflation is forecast to average over 2% for the coming 10 years,” says Mr Higham, “but inflation often hits retirees the hardest and their inflation rate could be as much as 4% to 5% a year.”

This is because the basket of goods considered by the CPI may not accurately reflect the typical spending habits of older generations, who tend to spend a greater proportion of their income on food, transport and heating. One of the best ways to counter inflation is to keep some of your money invested; alternatively, an investment-linked annuity should be able to deliver a rising income.

10. Don’t overlook the benefits of guidance and advice 

Royal London research shows that 40% of people who withdrew cash from their pensions did not take advice because “they had already made their mind up”.

“It is like people don’t want to be talked out of the decision they have made,” says Miss Tait.

Simon Kew, associate director at Deloitte, agrees and warns that following April’s pension reforms, a little knowledge can be a dangerous thing.

“Rather than listen to a friend in the pub, coffee shop or workplace, free initiatives such as Pension Wise are there to be consulted first and foremost. Then, if questions or doubts remain, seek independent financial advice.”

Whether you have made up your mind or not, check out the box above to find out how advice can add value to your plans.

What value can advice add to your decisions?

Inheritance tax planning
Widow Marion Taylor would like to take the money from her husband David’s £300,000 pension as a lump sum. He was 74 when he died.

Without advice: Marion could take the money tax-free to invest in a portfolio of cash and shares. But even though she doesn’t pay income tax on the money (because her husband died before 75), it now forms part of her estate and gives her children a potential inheritance tax (IHT) liability of £120,000.

With advice: Marion leaves money invested in a portfolio of cash and shares within the pension and has access to income and lump sums when required. Income and gains within the fund are largely tax free, and Marion can nominate to leave the money to her children on her death free of IHT, offering a potential saving of £120,000.
Source: NFU Mutual

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Your Comments

"Fiona Tait, pension specialist at Royal London, says only the first 25% of every withdrawal is paid tax-free." Is that true?  I understood you could take 25% of the total fund as a lump sum, tax free.

You can take 25% of the whole fund tax free at the start, and pay tax on the remainder as you draw it at the appropriate income tax rates (i.e. 0%, 20%, 40%, 45% depending on your income that year.)

Exactly. So nothing like "the 1st 25% of every withdrawal is tax free". I wonder where Moneywise gets its contributors from sometimes.

Hi, under new legislation (known as uncrystallised funds pension lump sum withdrawals) you can take money out of your pensionat any stage from age 55. The first 25% of these cash withdrawals is paid tax free and you pay tax at your marginal rate on the remainder. This might be you cashing in the entire pension or making partial withdrawals.  This tax only applies to cash withdrawals - if you take 25% tax free cash and put the remainder in flexi access drawdown or use it buy an annuity that tax charge won't apply.

I think that Fiona, in point 1, was referring to people cashing in the whole of their pension pots just to put most of it into general savings accounts - rather than someone going into drawdown.

Indded, that is maybe what she meant, but it is not what she said.  Pensions are complicated enough, without misleading and incorrect statements being made by those that should be helping and explaining.

Another misleading statement -  "The first 25% of these cash withdrawals is paid tax free and you pay tax at your marginal rate on the remainder."  This says that regardless of how much I withdraw from my fund, I will pay tax at my marginal rate on 75% of the withdrawal.  Not true.
If i have a fund of £100k and I'm over 55, I can withdraw £25k entirely tax free.  The remaining £75k may be taxed at my marginal tax rate when ever I choose to withdraw it, and that could be tax free too, depending on the allowances and my other income durring that tax year.

Portland Bill, we are not being misleading. It depends whether you: 

a) transfer your pension into flexi-access drawdown, which I presume is what you are talking about (at which point you can take up to 25% of the whole pot tax free), or

b) take small amounts of cash on an ad hoc basis which Fiona is talking about (each withdrawal is 25% tax free). 

Here's a link to an explanation from the Money Advice Service: