SECURING YOUR OLD AGE
Rebecca Atkinson from Moneywise
Thursday, November 12, 2009.
Editor's note: Please note that this article is targeted at UK-based readers. Always seek expert advice before making financial decisions.
We all make mistakes in life - but when it comes to pensions, even little mistakes can have a massive impact on your quality of life in retirement.
Here are some of the most common mistakes people make when it comes to pensions - and some tips on how to avoid them.
Assuming the state will provide
A recent report from Scottish Widows found that many women intend to rely on the state to fund their retirement, with nearly 30% of non-retired women admitting to having no private pension schemes. Of those, 44% say they have no intention of ever paying into a private pension.
And the problem isn't just limited to female workers. Stephen Haddrill, director general of the Association of British Insurers, says: "Our research shows that over 40% of people are either saving far too little, or nothing at all, for their retirement."
Not saving into a pension because you assume the state will provide for you in retirement is a big mistake. "The reality is, not only are people going to have to wait longer to receive their state pension [as the government intends to raise this] but there is no guarantee how much the state pension will be by the time they do leave work," says Laith Khalaf, pensions analyst at Hargreaves Lansdown.
Saving too little, too late
In the early days of your career, starting a pension is probably far down your priority list. But really, it is never too early to start a pension - in fact, the earlier you start, the better.
"£100 paid in when you are in your 20s is worth a lot more than the same amount when you are in your 50s - simply because it will benefit from years of growth," explains Khalaf.
Of course, when you are younger you may be reluctant to lock away your money in a pension, where access is blocked until you retire. Saving up for a mortgage deposit, for example, or paying off your debts might take priority, and having money in a rainy-day fund is also essential.
But even if you feel nervous about the finality of saving in a pension, you should still make an effort to put away some of your salary for retirement. Using your annual ISA allowance is a good idea, as any growth won't be taxed and you can still access your cash if you need to.
As soon as you are able to start a pension, however, you should. Matt Pitcher, wealth adviser at Towry Law, explains: "Some people see the fact that you can access your pension funds until retirement as a drawback, but I think it's a key advantage as it enforces the savings discipline. Plus, you receive tax breaks on pensions contributions - this will make a huge difference over the timescale of the pension."
Pensions offers full tax relief on everything paid into your pot - so if you're a basic-rate taxpayer, for every £100 going into the fund, you only pay in £80 and the government will add the other £20. For higher-rate taxpayers, you only pay in £60 of every £100 and the rest comes from the taxman.
As a general rule of thumb, Khalaf says people should aim to save around 15% of your salary in a pension. But, the later you start saving, the more you will need to contribute in order to offset missed years.
"Someone who starts saving in their 20s can get away with contributing 8% to 10% [including your employer's contribution,] - but if you wait until your 30s, you need to put in 15% to 20%," says Pitcher.
Even if you can't afford this type of contribution, Pitcher urges people to pay in what they can to their pension.
Not taking employer's contribution
Many employers will pay a contribution into your pension - but some will only do this if you also make contributions. So, if you pay in £100 of your salary each month, your employer will match this.
According to Khalaf, having to make their own contributions and give up part of their salary puts many people off starting a company pension. But he warns that this attitude could have dangerous consequences. "Not only are you losing out on tax relief on your contributions, but you are effectively turning down free money," he explains. "Plus, most importantly, you won't be saving for retirement."
Using the default fund
Pitcher says he often sees clients where 85% of a company's workforce pays into their company pension's default fund. This means you technically leave it to the people running your scheme to choose how to invest your pension contributions.
The problem with default funds is that, while it is chosen to suit many people, it might not be suitable for you as an individual. "People choose the default fund that their scheme offers because they don't have the time, interest or knowledge to pick their own funds," says Pitcher. "But it is always the bog-standard option.
He advises people look at the pensions literature their company pension scheme provides them with, to try and understand their own risk. Or you should seek specialist advice from an independent financial adviser.
Find an IFA in your area
Not reviewing your pension
Recent research from Prudential (PRU) revealed that nearly a third of people with occupational pensions pay no attention to how their retirement savings are invested. Furthermore, more than 2.5 million workers have never reviewed how their chosen pension fund is performing.
Andy Brown, director of investment funds at Prudential, says: "You routinely check your savings, utilities, insurance cover, mobile phone contract and broadband arrangements to make sure you're getting the best from them, and checking the performance of your pension should be no different."
Generally speaking, you should aim to sit down and review your pension scheme around once a year.
Not upping your contribution
Most of us adapt our lifestyles to our salary as our career progresses; so, when you start earning more, you also tend to spend more on the things that are important to you. This might be upgrading from a one-bedroom flat to a family home with a garden, or simply switching from a weekly meal Pizza Hut to a more 'upmarket' pizzeria.
The same should be true for your pension. While in the early days of your career, you may not be able to afford to pay much in each month, you should review your contribution level regularly to make sure you are really paying in as much as you can afford to.
Pitcher recommends people review their pension contributions every time they receive a pay rise, but you should also do this when there are other financial changes in your life. For example, when you pay off a personal loan or credit card debt, consider using the amount you will save each month to top-up your pension.
Stopping your contributions in a bad market
Getting your pension statement and realising that, despite paying in faithfully each month, your pot is worth no more - or even less - that it was the previous year is galling. But it shouldn't prompt you into stopping your contributions; this, says Pitcher, is "short sighted" and "hugely damaging".
In fact, he urges people to consider increasing their contributions during a bad market. This is because you can benefit from depressed market values, and hopefully cash in when values rise again. Basically, your money will buy you more investment units when they are cheap.
Plus, stopping your contributions could also mean your employer stops paying into your pension. "You might as well set fire to your own banknotes," says Pitcher.
Not protecting yourself during a divorce
When a marriage breaks down, pensions are probably the last thing on people's minds. For women, however, forgetting that their husband's pension is considered an asset could be a costly mistake.
If you have given up your job to care for children, for example, then your own pension may have suffered as a result. Even if you haven't, the fact remains that the majority of women will retire with smaller pensions than their male counterparts.
A lot of women don't realise that, if their marriage breaks down, then they could be entitled to part of their former partner's pension pot. This is because a divorce settlement will never treat a single asset in isolation; everything, including property, pensions, savings, investments and income, is taken into account.
As well as a lack of awareness, many women sacrifice their security in retirement in order to stay in the family home - especially if they have children. But they may regret this in later life, if they retire with a large house in their name but only a paltry pension to survive on.
Not de-risking your pension
As you approach retirement, you should think about moving your pension out of high-risk investments such as equities and into lower risk, fixed-interest options, such as gilts and cash. If you have a so-called 'lifestyle' pension, then this will be done gradually on your behalf; every year a chunk of your pension will be moved out of stocks and shares.
"With a lifestyle pension, you don't have to think about de-risking - it's all done for you," says Khalaf.
This can, of course, have drawbacks. For example, pension savers whose pots were moved from equities into gilts during the stockmarket rally will have seen their loses crystalised, but equally it can go the other way too. The problem is automatic de-risking does not take the current climate into account.
"In an ideal world, we would all use intelligent management for our pension funds, but in reality most people would rather not have the bother or worry," adds Khalaf.
If you intend to opt for income drawdown (where part of your pension remains invested when you retire,) rather than an annuity, then you may want to keep your pension fully or partly invested in shares, although it's worth moving at least some of your pot into a more stable asset.
Not getting a state pension forecast
YouGov research, commissioned by Foster Denovo, recently found that 83% of 25 to 54-year-olds do not know the value of their state pension.
Ian Bird, senior partner at Foster Denovo, warns that people who have no idea what their financial position will be once they retire are putting themselves at risk of poverty in retirement.
Remember, if you opt to defer receiving your state pension, the amount you will receive will increase by 10% for every year you leave it untouched. However, this growth may be offset by the income you could have received during the deferral years.
Not shopping around for an annuity
When you retire, your pension provider will offer you an annuity - this pays you a fixed (or inflation-linked) income for life.
Around two-thirds of people accept the first offer made to them by their pension provider, not realising that they have the option to shop around to see if they could get a bigger income elsewhere - this is known as the open market option (OMO).
Some financial advisers claim they have boosted client's retirement income by 40% to 60% simply but shopping around for their annuity.
The other benefit of using the OMO is that you could qualify for a so-called enhanced annuity. In recognition of the fact that some people have a shorter life expectancy than others, providers are increasingly offering people in poor health a larger income from their pension pot.
Nigel Barlow, head of research at Just Retirement, says: "The disparity between the income people could receive highlights the importance of shopping around for an annuity, rather than just accepting the one offered to you by your pension provider, and the importance of declaring any medical conditions."
Khalaf adds: "Most people don't shop around for an annuity, but this is such an easy way to increase your retirement income."
Forgetting about the impact of inflation
According to Khalaf, inflation is the biggest problem facing pensioners - yet many don't make provision to avoid the impact of rising prices. Around 90% of people use their pension funds to buy a fixed or level annuity, because they want the security of knowing how much annual income they will receive.
However, you can inflation-proof your pension by opting for an annuity that rises each year, either in-line with inflation (the retail prices index) or by a standard 3%. While you can expect to receive a smaller income in the years of your retirement, this is one way to prevent inflation eating into your buying power.
"Retirees could also consider a split annuity, where 50% is used to buy a level annuity and the remainder used to purchase an inflation-linked product," adds Khalaf. "That way they can receive a higher income from day one and still protect their money from the ravages of inflation."
Buying an annuity with a large fund
Around 90% of people due to retire this year are expected to buy a lifetime annuity - but for those people with large funds, this could be a mistake, warns Pitcher. He suggests anyone with a pension pot of £100,000 or more should consider income drawdown (also know as an unsecured pension) as an alternative.
While most people will still have to buy an annuity by the time they turn 75, income drawdown effectively allows you to keep part of your retirement savings invested - giving the potential for further growth.
You can still take an income from income drawdown; this can be varied each year up to 120% of the value you could have earned from a standard annuity.
"Most people need more money in the early years of their retirement, and less as time goes on," explains Pitcher. "Income drawdown offers more flexibility as you can draw a bigger income before the age of 75, and then settle down with a level annuity."
With thanks to Interactive Investors.