Saving for retirement is probably your most important financial goal. There will come a point when you are no longer working and are reliant on the assets you have built up during your working life. This means unless you are a member of a very generous defined benefit scheme, you will need to take steps to plan for your retirement.
Many people don’t think about this regularly, or put it off until later in life. But the earlier you start planning, the easier it will be to create your ideal lifestyle in retirement.
Avoiding some common mistakes is a great place to start.
Not Contributing Enough
On average, an individual needs at least £12,800 per year to achieve a basic minimum living standard in retirement. There is not a lot of room in this budget for luxuries, holidays, or spending money on hobbies. Most people will want to spend more than this, particularly if they are used to having more disposable income.
Bear in mind that the State Pension is currently £10,600, which is a good start, but doesn’t quite cover the basic living standard mentioned above. Most people are not contributing enough to achieve the lifestyle they want.
The following tips can help you make sure you are saving enough for retirement:
- If you are employed and eligible, make sure you are opted into your workplace pension
- Consider making top-up contributions or setting up a private pension. You can receive tax relief on your contributions, which is particularly valuable for higher or additional rate taxpayers.
- A pension calculator can help you work out how much pension income you are likely to have, as well as the impact of increasing your contributions or changing your retirement date.
Investing Without a Plan
Investing can be complicated, particularly as we now have the entire investment universe at our fingertips.
Some common investment planning mistakes include:
- Investing in risky assets or concentrating too much in one area.
- Not taking enough risk. This can lead to inflation outstripping returns and losing money in real terms.
- Trying to time the market or make judgement calls about which assets are likely to outperform at any given time. Even professional investment managers often get this wrong.
While you can afford to make some investment mistakes early on, they can be difficult to recover from the closer you get to retirement.
A financial adviser can help you create a long-term investment strategy which is aligned with your goals.
Overfunding your Pension
Overfunding your pension can have tax implications and restrict your options later on.
Typically, you can make gross tax-relievable pension contributions of up to:
- £3,600 gross (£2,880 net, taking into account tax relief), whether or not you have an income.
- Your relevant UK earnings, for example, salary or trading profits.
- The annual allowance, currently £60,000. This can be carried forward by up to three tax years, however if you are making the contribution personally, the above earnings-based limit still applies. Anyone earning over £260,000 will have a tapered annual allowance.
- Employer contributions are not limited by earnings, but are subject to the annual allowance.
You can find out more about the limits and tax relief here.
The main risks of paying too much into your pension are:
- You may not receive full tax relief on your contribution.
- If your employer makes the contribution, you will pay tax as if you were paid an income, despite not actually receiving the money.
- The contribution will be tied up in your pension until you reach the minimum retirement age.
- You could then be taxed a second time when you eventually take benefits.
While the Lifetime Allowance has now been abolished, there are still some limits on tax-free cash and tax-free death benefits.
If you are at risk of overfunding your pension, it may be worth seeking financial advice to find out other tax-efficient ways to invest.
Triggering Tax Penalties
An important tax trap to be aware of is the Money Purchase Annual Allowance (MPAA).
This means if you take flexible benefits from your pension, your future contributions will be limited to £10,000 per year. You will also lose the ability to carry forward.
The MPAA is not triggered if you tax tax-free cash, buy an annuity, draw a scheme pension, or if you take benefits from a pension which was already in capped drawdown prior to 2015. There are also special rules for small pots.
The MPAA could affect your retirement plans if you take benefits while you are still working, or if you retire but decide to return to work later on. You could miss out on significant amounts in future tax relief.
It’s a good idea to look at other options for supplementing your income or covering ad hoc spends before drawing on your pension.
Taking Benefits Inefficiently
Pensions grow tax-efficiently, and they are outside your estate for Inheritance Tax (IHT) purposes. This means it can be sensible to draw on other assets first, giving your pension longer to grow.
A common retirement planning mistake is to take too much, too quickly from a pension, possibly leaving cash and other investments untouched. Not only is this inefficient from a tax point of view, but it could also result in running out of money earlier.
Generally, less tax-efficient, lower risk assets should be drawn on first, for example:
- Cash
- Taxable investments, using allowances where possible
- ISAs
- Pensions
Not Reviewing Your Pension
Regular reviews are one of the most important aspects of financial planning. Circumstances can change and investments may perform differently from predictions.
It’s worth taking some time to review the following:
- Have your circumstances or goals changed?
- Are your contributions still on track or do you need to make adjustments?
- Are your funds still suitable and performing as expected?
- Are the costs of your plan still competitive or can you get a better deal elsewhere?
- Does your pension provide all of the features and benefits you require?
If you have multiple pensions spanning many years, it might be a good idea to contact a financial adviser for a review.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
The value of an investment can go down as well as up.
content in this article was correct on 09/04/2024.
You should not rely on this article to make important financial decisions. Teachers Financial Planning offers independent financial advice on savings, pensions, investments, mortgages and mortgages for teachers and non-teachers. Please use the contact form below to arrange an informal chat with an adviser and see how we can help you.