Avoiding pensions traps

On 6 April 2015, the defined contributions pension landscape changed, almost beyond recognition. The most radical changes to pensions in almost a century turned what was once a very rigid savings vehicle, into a fully flexible product overnight. With these new freedoms, however, come new responsibilities and, without proper planning, commin mistakes could leave pensioners in poverty.

Common mistakes to avoid when planning your retirement:

  1. Not saving early enough: time is key with pensions. The later you start saving the larger the contributions you need to make. For example, if you invested £2,500 for a child when they were born and again on their first birthday, without making any further contributions, at age 70, they could have a retirement pot worth more than £550,000 (assuming 7% returns per annum). If they only started saving when they were 30, they would need to save £2,180 per annum for 40 years (a total of almost £90,000) to achieve a similar-sized pot. Leave it another ten year and they would have to save £4,580 per annum for 30 years (more than £140,000) to get the same result.
  2. Underestimating how much money you will need: according to RedSTART, a financial education initiative, you need at least £200,000 simply to retire on the current living wage (the amount an individual needs to earn to cover the basic costs of living) and £400,000 to achieve the average wage*. If you want to enjoy a comfortable retirement you may well need in excess of this amount.
  3. Outliving our savings: We are living longer now. According to the Office of National Statistics, one in three children born today will live to be 100. Many people may have 30 years or more in retirement, so we need to make our pensions last as long as we do. This may well require us to evolve our thinking about how we allocate our investments. Instead of moving into bonds and cash as we reach retirement age, we will probably need to retain a much higher weighting to equities for longer. That way, our pot of money can grow/replenish itself while we withdraw a regular income.
  4. Falling into a tax trap: there are different tax implications now, so we need to take care that we are not caught out and end up paying more to the taxman than is necessary. Remember: withdrawing your pension whilst still working can push you into a higher tax bracket. Even if you are no longer working, withdrawing too much money could also result in a tax liability you hadn’t foreseen.
  5. Getting taken for a ride: unfortunately, there are some unscrupulous people around, looking to take advantage of the new pensions freedoms. Be very careful not to be unwittingly caught out. Cold calls and unsolicited emails should be treated with extreme caution. If the offer looks or sounds too good to be true, it probably is.

*RedSTART, April 2015. Underlying assumptions are Male and annuity at 68 years old. Living wage and average wage: http://www.bbc.co.uk/news/business-25759780

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