Get the most out of your pension..

Choosing the right retirement path is complex – but vital

PLANNING your retirement can be a tricky business, especially when it comes to choosing what to do with your pension savings.

If you’re lucky enough to have a final-salary scheme, then you don’t have to worry too much as you’ll be paid a guaranteed income for life.

But if you’re one of the increasing number of people approaching retirement with a defined-contribution (DC) or personal pension, then you have to make all the decisions – and take on all the risks – as to what to do with your pot.

The Financial Conduct Authority has recently raised concerns that many people are making poor financial decisions when it comes to accessing DC pensions.

They include taking some of the money out and moving it into cash savings, and simply accepting the offer from the firm they have saved with and not shopping around for the best deal.

More and more people are not seeking advice to help them make a decision that will affect their finances for the rest of their life.

Chris Woolard, executive director at the FCA, explains: “We know that choices introduced by the pension freedoms have been popular with many consumers. However, they are now required to make more complicated decisions than ever before. Many people need more support when making choices.”

Before the pension freedoms, most people bought an annuity, which guarantees a lifetime income. In the last three years the popularity of annuities has fallen drastically and been replaced by income drawdown, where you leave your money invested and withdraw cash as you wish.

The increasing use of drawdown introduces new risks and complexity, making it easy to get things wrong.

Andrew Tully, pensions expert at Retirement Advantage, says: “The increasing popularity of drawdown has transferred all of the risks of retirement to the individual. Without the right guidance and advice, it is all too easy to make mistakes, which can often prove irreversible.

“The ability to dip into your pension like a bank account introduces many new risks, including paying too much tax on withdrawals, or being scammed out of your money. Equally, it is very difficult to judge how much money to withdraw, as you either run the risk of running out of cash before you die or could be recklessly conservative and not draw enough.”

Given the increasingly popularity of drawdown, we explain the key risks to be aware of...

Investment

Investing in retirement to generate an income over 20 years or more is completely different to saving for retirement. Money invested in the stock market can go down as well as up, and if you withdraw cash when stock markets are going down, you may never make up your losses.

The FCA has found that many people are making poor investment decisions because they simply put the money into cash, but could receive 37% more income each year by making better investments.

Sustaining an income

You need to work out when to withdraw an income, how much to withdraw and how long you need that income to last.

A common rule of thumb is that it’s OK to withdraw around 3-4% a year from your pot, but much depends on how your investments perform.

Shopping around

Many people follow the path of least resistance and simply accept the offer from their current pension provider, rather than comparing what’s on offer across the market to find the best product or rate. The FCA is concerned people are not always getting a good deal, and that some people could be paying higher charges than necessary.

By simply switching provider you could increase your drawdown income by 13%.

Tax

After taking the tax-free lump sum you’re allowed to take from savings (typically 25% of your pension pot), any future withdrawals are subject to income tax if you have income of £11,850 or more in any one tax year.

This is called your personal allowance and includes state pension and salary if you still work, as well as your pension income.

Once you’ve accessed a pension, you are limited by the taxman to the amount you can continue to save into a pension (restricted to £4,000 a year). But the good news is that any unused pension can be passed on to younger generations taxfree if the money is kept in the pension and you die before age 75.

Scam alert

The pension freedoms have opened the floodgates to crooks who want to steal your money by offering toogood-to-be-true investment returns, free pension reviews, and access to your cash taxfree or before the age of 55.

The Government is currently consulting on how to ban pension cold calling, but there has already been a delay implementing this ban.

If you are contacted out of the blue, run a mile. No financial company or adviser will make unsolicited contact with you.

Advice

It costs to get professional advice on your pension options, but this can be money

It’s so easy to make mistakes which can often prove irreversible

well spent as it could help you avoid paying too much tax, ensure you find the right option for your financial needs – and avoid losing your nest egg to fraudsters.

Unknowns

Retirement can last many years, with average life expectancy for a 65-year-old man around 86 (you have a one in 10 chance of reaching 99).

Making your pension last as long as you do is probably one of the biggest challenges. You may also face the loss of a partner or divorce or the prospect of paying for long-term care.

Governments also have the habit of moving the goalposts and changing the rules of the game as they continue to make pensions more and more complex. Just a few years ago, drawdown was the preserve of the wealthy minority who were prepared to take on the risks and costs of managing their own retirement.

But in a short space of time it has become the norm – yet the risks and costs involved haven’t changed.

Andrew Tully adds: “More people are now ‘DIY drawdowning’ without financial advice, and that number is increasing.

“Sorting out your pension is complex, so speak to Pension Wise, get guidance and ideally look for a proper regulated financial adviser before deciding what to do, if anything, with your pension.

“This will ensure you don’t get tripped up by any of the risks highlighted here and can hopefully simply enjoy your retirement to the full.”