10 pension mistakes you can't afford to make
Many Brits are facing a pension shortfall. The average pension pot at retirement is £43,000 according to the Association of British Insurers.
However, annuity provider Retirement Advantage says it takes a pot of around £175,000 to generate an income of £10,000 a year - what the majority of people say they would need in retirement.
So if you want to ensure you have enough money to live comfortably when you retire, here is our list of the top 10 pension mistakes to avoid.
1. Not having a pension at all
The basic state pension this tax year is just £115.95 a week plus any means-tested benefits but this will rise to a maximum flat rate of £155.65 from April 2016 for those that have paid 35 years of National Insurance.
With both amounts equating to incomes of well below £10,000 a year, this is nowhere near enough to maintain a reasonable standard of living.
"And with the state pension age also rising - up to age 68 and potentially beyond - those wanting to retire in their early 60s will need to have other resources to live on," says Danny Cox, head of financial planning at Hargreaves Lansdown.
Saving into a pension can offer real value, especially because of the tax advantages.
For example, tax relief on a pension means that for every 80p a basic-rate taxpayer saves for their retirement, the government tops it up to £1. Higher-rate taxpayers, meanwhile, get 60p topped up to £1 and additional-rate taxpayers see 50p topped up to £1.
2. Delaying your pension saving
The two biggest factors that determine how much your pension will be at retirement are the amount you put in and the length of time you invest it for. "The sooner you start saving into a pension the better, even if you are saving a small amount," says Cox.
Legal & General research reveals that to achieve an annual pension income of £10,000 by the age of 65, if you start saving at the age of 25 you would need to save £105 each month. Leave it until you're 35, and you'll have to find £195 a month; until 45, £405 a month; and wait until you're 55, £1,100 a month.
Julie Russell, head of customer relationships at Standard Life, says: "As a general rule of thumb, people should be saving about half of their age as a percentage of their income. So if they start when they are 20, they should be saving 10% of their income each year into a pension, but if they leave it to 30, they need to save 15% of their income into a pension each year."
And remember that while 10% may sound like a lot of your salary to divert each month, especially early on in your career, most employers match any contributions you make to your pension. So to put 10% of your salary into your pension each month, you may only have to stump up 5% yourself.
3. Opting out of your company pension scheme
If you opt out of your workplace pension scheme, you could miss out on thousands of pounds. This is because lots of companies match employee contributions so ignoring a company pension scheme effectively means saying no to free money.
While not all companies offer pensions, since October 2012, new regulations have come into force automatically enrolling workers in the UK aged over 22 into an employer pension scheme.
So far, only those working for large and medium sized companies have been swept into a scheme, but all employees will be auto-enrolled by 2018. All employers will have to add to your contributions.
All workers do have the right to opt out of the pension scheme, but you will be automatically re-enrolled after three years or if you change employer.
4. Thinking your home is your pension
Sean Oldfield, chief executive of property investment company Castle Trust, says it is wrong for most of us to consider our home as our pension.
He cites three reasons. First, the probability of ever benefiting from an increase in the value of your home is actually quite low. "You will always need a roof over your head - so if the home you're living in is supposed to be an investment, how do you sell it and crystallise any gain?" he asks.
Second, your home would be the only investment that you keep paying into, to suit your changing needs and tastes. "On top of the mortgage interest, there are constant upkeep, repairs, insurance and other costs, all necessary to make it your home," he says.
Lastly, he believes the sentiment that "my home is my pension" is an excuse to justify ploughing so much money into bricks and mortar while making no real pension provision. "Your home only becomes an investment when you are prepared to sell it and trade down for the rest of your life."
The same rule also applies to pension saving as to investing: don't put all your eggs in one basket.
5. Being too cautious
"A common problem in pension planning is to not take enough risk when there may be a 20, 30 or 40-year timeframe before taking benefits," explains Cox.
However, over the long term, investing - while undoubtedly more risky than holding your money in cash - provides the best opportunity to grow your pension fund over and above the rate of inflation.
In fact, holding your money in cash or low-risk investments can be riskier than investing in racier markets.
For example, according to analysis by Barclays, an investment of £10,000 in the shares that make up the UK FTSE All Share index between January 1985 and the end of June 2010 would have grown by more than 11 times its original value. Cash, meanwhile, would have increased by just over two-and-a-half times during the same period.
6. Sticking with default funds
If you don't choose your pension investments, your money will most likely be sitting in a 'default fund'. The problem with this is that the performance of these funds can vary greatly, and they also tend to be fairly cautious.
For example, if you had invested £20,000 in an average pension default fund such as the ABI UK Mixed Investment 40-85% Shares fund, over the past 20 years your money would have grown to £72,149, according to Hargreaves Lansdown.
However, had the money been invested in something a bit more racy such as the AXA Framlington Managed Balanced fund instead, it would have grown to £107,041.
7. Stopping contributions in a bad market
When stockmarkets fall and the economy falters, many investors get nervous. Some decide to stop contributing to the pension in case the value of the funds they are invested in falls. But this could be a mistake.
When the markets fall in value, it is actually cheaper to invest as unit costs are reduced. And their bravery will be rewarded when recovery comes along.
8. Failing to review your pension regularly
Do you know how much your pension is worth? Do you know how many you have or where they are? How about the type of funds they're invested in or how much risk is involved?
If the answer to any of these questions is no, you need to take stock and plan to review your pension at least once a year and every time your personal circumstances change. Make sure your pension is on track to grow enough to support you in retirement.
9. Ignoring charges
Pension companies and investment professionals invest your contributions to make cash. So you'll probably pay them a long list of fees, including an annual management charge (AMC), exit or transfer fees and advice fees.
These fees are often given as a percentage and at first glance can seem quite small. For example, an AMC of 1.5% on an investment of £1,000 would equate to just £15. But if you invested £1,000 a year for 20 years, assuming no growth, you would pay £253 in charges in year 20 - that's nearly 25% of one year's contributions being swallowed up by charges.
"Many workers don't realise the extra hidden fees they pay for pension funds can erode the value of their retirement pot by as much as 40% - a staggering amount and a national scandal," says Gina Miller, co-founder of wealth manager SCM Private.
10. Not shopping around for guaranteed income
You can now spend your pension savings as you wish, but if you do use some or all of your pension fund to buy an annuity (which provides a guaranteed income for life), it's vital you shop around for the best deal. However, around two-thirds of retirees plump for the first rate they are offered by their existing pension provider, which can be a very costly mistake.
"If people buy an annuity from their existing pension company without shopping around, they may be losing possibly tens of thousands of pounds over their retirement years," says Stephen Lowe, director at annuity specialist Just Retirement. "That's because there are significant differences between the best and worst annuity rates in the market."
Choosing a competitive annuity rate can improve your retirement income on average by as much as 20%. However, if you are eligible for an enhanced annuity because you are in poor health or are a heavy drinker or smoker, your income could go up by around 40%.
Find out everything you need to know about the new pension rules and how to plan ahead for the retirement you deserve with our new magazine, How to Retire in Style. The magazine is available to buy now from all leading newsagents, or can be ordered online at moneywise.co.uk/retire
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.