Ten pension mistakes people make before retirement

Financial education and guidance provider Wealth at Work outlines below the top 10 pension mistakes people could make, to highlight what those facing retirement may need support with.

1. Withdrawing savings from a pension early

As a result of the rising cost of living, one in 10 (10%) over 55s in fulltime employment have withdrawn pension savings earlier than previously intended to supplement their income, yet 31% say they intend to or may consider it in the future, according to a survey from Wealth at Work[1].

The firm says withdrawing money out of a pension earlier than planned really should be a last resort and people must understand the dramatic impact this can have on retirement savings, which could include either having to work longer or having less income in retirement.

2. Not understanding how pensions are invested

When it comes to pensions, individuals may not understand that pensions are often invested in so-called ‘lifestyle funds' which typically move investments out of higher risk funds investing in things such as shares, into lower risk funds investing in assets including bonds and cash, as people approach their chosen retirement age.

This made sense when the majority bought annuities, as they didn't want to risk a market crash's impact on their savings just before retirement. However, many people now access their pensions using income drawdown[2], meaning that it generally may be better for their pensions to stay invested in equities long into retirement, to give their money the potential to keep growing. Individuals should speak to their pension provider to find out what investment path they are on, and if it is aligned with their retirement income plan.

3. Missing out on lost or forgotten pensions

The total value of lost pension pots has grown from £19.4bn in 2018 to £26.6bn in 2022[3]. Some of the main reasons this occurs can be moving jobs, or people moving house and not updating their address with their pension provider.  

If someone has a lot of different pensions, they may want to consider consolidating them into one pension pot, especially as they may all have different investment strategies. It can also make it easier for them to manage their finances and could save them money on the fees charged. However, it is important to ensure there aren't any enhanced features or protections that could be lost by transferring, and that the scheme chosen provides the flexibility required for when accessing the money in retirement.

4. Not shopping around

Many people are choosing to use income drawdown instead of an annuity. However, it's crucial that people shop around to make sure they are getting the best deal. In a 2022 investigation, Which?[4] found that the difference in growth between the cheapest and most expensive drawdown plans for a £260,000 pot was nearly £18,000 over a 20-year period.

5. Withdrawing cash to put in the bank

Some people are taking money from their pension just to put into their bank account or other savings and investments, but they may not be aware that by doing this their money could lose value over time, as returns on savings accounts typically don't keep pace with inflation. They will also lose out on the valuable tax benefits available in the pension scheme. It's usually better to leave the money invested in a pension fund where it keeps its tax-free status, and only withdrawing when it is actually needed.

For example, if someone took £20,000 from their pension, they could receive the first £5,000 (25%) tax-free. The remaining amount would then be taxed as earned income, which for a basic rate tax-payer would mean a tax charge of £3,000, leaving them with £17,000 net of tax. If this was then deposited in a savings account, they would then only be receiving interest on this lower sum (£17,000 rather than £20,000) and the money would also form part of their estate for inheritance tax purposes.

6. First time high-rate tax payer 

Some people don't realise that income tax is due on their pensions once the 25% tax-free lump sum has been taken. This means that someone who has never been a higher rate tax-payer, suddenly could find themselves in that bracket, especially if they are still working.

For example, if someone aged over 55 is earning £40,000 a year and has £30,000 in pension savings, decides to withdraw all their pension, 25% of this (£7,500) would be tax- free, but the remaining £22,500 would be eligible for tax. Their taxable income for that year would be £62,500 (£40,000 salary and £22,500 pension), meaning that they would become a higher rate taxpayer. This means they would be taxed 40% on the £12,230 income that exceeds the £50,270 higher tax threshold.

For many, other savings and investments may be a better source of short-term cash than pensions, especially whilst still working, as it can help to avoid unnecessary tax being paid and allows the pension to grow in a tax-free environment.

7.  Not considering all savings

When deciding how to access retirement income, it isn't just about pension savings. It is important to look at all savings and investments, whether they be pensions, ISAs, or shares, to make sure they are being used in the most tax efficient way. 

Instead of taking money from their pension, some people might be better off using their other savings which aren't growing tax-free and liable for income and inheritance tax (such as general savings, shares and cash), and leaving their pension to grow in a tax-free environment until needed.

8. Underestimating or overestimating life expectancy

Before withdrawing from a pension, it is crucial to think about if you will have enough money to last throughout retirement. Many people can potentially live longer than they expect to, and therefore may underestimate how long they think their savings need to last. According to recent research[5], people aged 50 and over, on average, think they will live until around age 80, whether male or female. However, according to the ONS life expectancy calculator, a male aged 50, will on average live to age 84, while a woman aged 50 will live on average to age 87.

There is also a real risk that people underspend[6], and that they can be too cautious in retirement. Often the early years are the most expensive, when individuals are hopefully well enough to enjoy retirement, and possibly travel. In most cases, the amount needed declines into retirement unless care is needed, individuals should ensure they keep this in mind when planning their retirement spending.

9. Losing life savings to pension scams 

Individuals getting scammed out of their retirement savings is a real issue. The pensions regulator (TPR)[7] estimates that £2.5trn worth of pension wealth in the UK is 'accessible' to fraudsters, which represents a 'huge target base for criminals'. 

Whatever someone is planning to do with their retirement savings, it's vital they check whether the company they're planning to use is registered with the Financial Conduct Authority (FCA). They can also visit the FCA's ScamSmart website which includes a warning list of companies operating without authorisation or running scams.

10. Not getting help from the right place

When it comes to getting support with their pension, research from Wealth at Work[8] has indicated that more than half (56%) of working adults say they speak to unqualified sources such as family, friends or colleagues, or no one at all. Very few speak to their pension provider (15%), employer (13%), a regulated financial adviser (8%) or specialist bodies such as Pension Wise (4%) or Money Helper (3%).  The good news is that recent findings have indicated that employers are set to boost workplace financial wellbeing support. 44% of employers plan to offer targeted support for over 55s, and 68% already offer or plan to offer pre-retirement planning. It's important for those in the workplace to understand the help and guidance available to them.

Wealth at Work director Jonathan Watts-Lay said: "Often individuals have spent most of their working life saving into their pensions which may need to last more than 30 years. It is important that employees can make informed decisions based on what is right for them." 

He adds; "There is a lot at stake, and unfortunately mistakes can be made. However, with appropriate support made available in the workplace, employers can help their employees to make the most of the savings they have. Many employers are now seeing the benefits of putting robust processes in place to support their employee's at-retirement. This includes offering services such as financial education seminars and one-to-one financial guidance or financial coaching, in the months or even years before retirement, as well as facilitating an introduction to a regulated financial advice firm which has been through a thorough due diligence process. This approach should ensure an improved retirement process, leading to better outcomes for all."