We highlight the main hurdles to overcome when considering your retirement options
1. Cashing in pensions ‘just because you can’
Whoever said: “A bird in the hand is worth two in the bush” obviously was not 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 is not available from other sources, such as Isas (where withdrawals will not be taxed).
According to research conducted for the Financial Conduct Authority (FCA) 2018 Retirement Outcome Review, 27% of people who fully cashed in their pension did so to move it into a Cash Isa or bank account because they found it easier to understand.
“This reflects a lack of confidence in pensions which must be addressed as it could potentially be a very costly mistake,” explains Fiona Tait, technical director at specialist pension adviser Intelligent Pensions.
“Pension rules allow you to withdraw up to 25% of your fund tax free, however the remaining 75% is subject to income tax so it is more efficient to keep your money within the pension unless you need it to live or meet a specific expense,” she explains.
“This is made worse by the fact that the money is taxed at the emergency rate, which is nearly always higher than the amount you are actually due to pay, meaning the amount you initially receive can be much less than you expected,” says Tait.
Any emergency tax paid can be reclaimed, nonetheless it is highly unlikely that any returns you earn on your money will cover your full tax bill, especially if it is left sitting in cash.
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 much higher than today. However, according to research from the FCA, some 68% of GARs are not being taken up, rising to 79% for pension pots worth less than £30,000.
Even on small pots that you might be otherwise be tempted to cash in, GARs can be too good to ignore, as Claire Walsh, head of advice at financial adviser network 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 receive 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 remains low. According to the latest figures from the FCA, 54% of purchasers bought their annuity directly from their pension provider.
Andrew Tully, technical director at Canada Life, 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 Canada Life show that a healthy individual buying the worst deal could miss out on as much as £3,600 in lost income over a typical 20-year retirement (based on the average £61,000 annuity). You can shop around for annuities on comparison websites and with annuity brokers. Alternatively, you can consult a financial adviser.
4. Hiding health problems from annuity providers
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 are likely to have a lower life expectancy and, as such, specialist annuity providers are able to pay you a higher income.
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.”
Figures from insurance firm Retirement Advantage show that a less healthy retiree with a pension pot worth £61,000 could miss out on £25,140 over 15 years by not getting an enhanced annuity compared to the best standard rate.
Specialist annuity providers estimate that between 60% and 70% of retirees would be eligible for an enhancement of some kind. However, most pension companies do not offer them, so you are only likely to come across specialist providers if you shop around.
5. Assuming you will get a full state pension
The new, or flat rate, state pension (introduced in April 2016) pays a headline rate of £175.20. To qualify for the full rate, you need to have paid 35 years’ national insurance contributions (NICs). People with less than 10 years’ NICs will receive no pension, while those with between 10 and 34 years will get a proportionate amount.
Everyone has their own entitlement and crucially this means that married people will not get the benefit of contributions their spouse has built up and there is no special treatment for people who have been widowed or divorced.
If you are approaching state pension age now, you will have built up some entitlement to the additional state pension (which topped up the old basic state pension) before it was scrapped in April 2016. This will be reflected in your new state pension payment and means you may get more than the flat rate.
To find out how much state pension you are currently eligible for, you can get a state pension forecast online (Gov.uk/check-state-pension). If you are not eligible for the full amount, you may be able to buy NICs to top it up.
6. Underestimating your life expectancy
With an annuity, your income will be guaranteed for life – so even if you live until you are 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 do not 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 he is 88, while a woman 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,” McQueen explains. “So someone on the west coast of Scotland is likely to live five years less than someone in South-East England.”
7. Forgetting to track down old pensions
Today’s workers can expect to have an average of nine jobs over their working life, so it is 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, with worrying research from LV= showing that one in 10 people thinks they will lose their pension when they leave their employer.
The Association of British Insurers believes that as many as 1.6 million pensions have been lost, worth a collective £19.4billion – an average of £13,000 per pension pot.
The good news is that if you think you have a plan that has gone AWOL, you can track it down using the Government’s Pension Tracing Service (Gov.uk/find-pension-contact-details).
It will not be able to tell you the value of your pension but it can give you the contact details of schemes you are a member of, allowing you to be reunited with your savings.
8. Assuming your situation will stay the same
As life expectancy continues to rise, there is every chance you could be retired for 20, 30, or maybe even 40 years, and a lot can happen in that time.
Tait says: “Government statistics show that a 65-year-old man has an average life expectancy of 20 years with 10% living to age 96. During this period the chance of him getting married has increased by 46% in the past decade while 23% of men in this age group may get divorced.
“Longer lives also mean that the chances of being in good health throughout retirement is decreasing and only 8.9 years of those 20 years will be disability-free, raising the possibility of having to pay for medical care at some point.”
On the other hand, it may just be that your 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 do not factor the rising cost of living into your budget you may struggle in the years to come.
Tait says: “The official inflation rate has remained fairly low over the past 20 years but those in their 60s may still remember when it reached a peak rate of 24% in the mid-1970s.”
She adds: “It should also be remembered that inflation can have a significant impact and even low rates can have quite an impact over a period of 20 years or more.”
One of the best ways to counter inflation is to keep some of your money invested.
10. Don’t forget guidance and advice
According to research conducted by the FCA, prior to the pension freedoms (which were introduced in April 2015) only 5% accessed drawdown without taking advice. By 2018/19 that figure had rocketed to 48%. Only 15% of people took advantage of the Government’s Pension Wise, which offers free guidance.
Tait says: “Responses to the research questions indicate that many people were quite confident in their decision to take money out of their pension, despite not being confident that they understood the options available to them.”
The research suggests that decisions are largely being driven by the fact that savers can access their pensions, rather than whether they should.
Aside from the tax charges associated with pension withdrawals, Tait says people also need to consider the impact of taking cash out on their long-term financial security.
“Financial advice is often as much about stopping you from doing things that are not in your interests as recommending things that are. It may not be what you want to hear but knowing whether having a holiday now will put you at risk of facing poverty when you are no longer able to generate earned income due to age and health is a good thing,” she explains.
Simon Kew, director, head of strategy and relationships at Deloitte, agrees and warns that 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 the Pension Wise are there to be consulted first. Then, if questions or doubts remain, seek independent financial advice.”
Professional advice can be particularly helpful when it comes to working out how much money you can afford to take out of your pension, without running out of cash.
Tait adds: “Paying for financial advice could result in lower tax charges, higher eventual income and a greater chance of being able to meet your bills for longer.”