Maximise your UK pension by avoiding the main dangers
There are many UK pension planning dangers to avoid.
Consolidate your UK pensions from previous employments
Consolidating your pension pots from previous employments into one flexible pension account is usually cheaper to administer and easier to understand, with a single balance that you can check any time.
Consolidation allows you to take your savings out of old defined contribution schemes, where the charges are often excessive and the investment record poor, and switch to a more modern plan with a wider range of investment options, including lower-cost funds. Older pension schemes are also unlikely to offer flexible ways to access your money at retirement.
There are two scenarios where consolidation may not be beneficial, however. The first is if a legacy scheme offers a guaranteed annuity rate. These can be nearly double rates on the open market. The second is where a legacy pension allows you to take out more than the usual 25% of that particular pension tax-free – in some cases as much as 75% was permitted.
Do not opt out of your company pension scheme
All employers must now pay at least 3% of an employee’s salary into a pension scheme, so opting out of your workplace pension means forgoing thousands of pounds of free money. Many companies even match employee contributions, often up to 6% or 8%. Any scheme with the Pension Quality Mark (PQM) accreditation must have total contributions of 10%, of which at least 6% is paid by the employer.
Employers that provide salary-related pension schemes effectively make even more generous contributions of 15% or more, to be able to meet their benefits promise. If you have already left your employer’s scheme, you can opt in again by speaking to the HR department. Your employer is also required to automatically enrol you back into the scheme 3 years after you opted out, provided you meet the eligibility criteria.
Check your workplace pension is using your correct retirement age
Many workplace defined contribution (DC) pension schemes have a default fund that de-risks as you get closer to retirement age, switching out of equities and into more conservative investments such as bonds and cash, 5 or sometimes up to 10 years ahead of retirement. This is to prevent big drops just before you retire.
It has been found that an employee earning £27,664 and automatically enrolled in a workplace pension since 22 years of age would enjoy a fund value of £137,600 if their retirement age was set to 68, but the impact of switching to low-risk investments earlier would have produced only £127,700 if their pension age was recorded as 60. Check with your pension provider what age they have for your retirement age.
Do not be overly cautious in your investment choice
People frequently take an overly cautious approach towards their investments, but the long investment horizon until retirement – of perhaps 20, 30 or even 40 years – makes investing in low-risk assets the worst thing they can do. A £200,000 investment over 20 years in a cautious asset mix portfolio generated returns of £249,068, compared with £342,126 in a more adventurous asset mix portfolio.
Claim child benefit
A significant number of mothers are losing state pension by not claiming child benefit. Claiming for a dependant under 12 gives you a national insurance (NI) credit towards the qualifying years required for the state pension, even if you are not employed. Each qualifying year is equal to £231 a year in state pension. The credit is only given to one parent, the lower earner or the one who is not working needs to be the claimant.
The problem has arisen because a rule change in 2013 stipulated that anyone earning over £50,000 a year loses some of the family’s entitlement to child benefit, so many couples stopped claiming. However, around 200,000 couples could benefit because the lower-paid spouse is not accruing the pension credits they are entitled to for looking after a child. You can remedy this by transferring the credit to your spouse, even historically. You will need to complete form CF411a to transfer the child benefit credit.
Who you want to inherit your pension
Many people have not changed their beneficiary in their employer’s pension scheme since they were first asked to complete paperwork on joining the scheme.
Over 750,000 people aged between 55 and 64 who had remarried by the age of 50 have out-of-date paperwork and are at risk of passing their pension pot on to an ex-partner on their death. If someone nominates their spouse, but later divorces and fails to update this paperwork, the scheme’s trustees may be obliged to respect the recorded wishes.
You need to complete an expression of wish form or beneficiary form to change your plan.
Consider alternatives to the default fund
If you are intending to move your UK pension into drawdown and take an income directly from your Defined Contribution investment pot when you retire instead to using the money to buy an annuity, it is not good to de-risk in a default fund as you approach retirement age, as you will need to maintain equity exposure to generate that income. Your pension scheme will offer alternatives to the default option and you can switch into one of those.
Don’t withdraw cash simply to put it in the bank
You can now take pension cash from age 55, but typically it is not prudent to do so until you have retired, particularly if your intension is to do is pay it into your bank account or other savings account. This could result in you paying too much tax, as well as missing out on the benefits of your pension pot remaining invested.
The first 25% withdrawn from a pension is tax-free, but the remainder is taxed at your marginal rate – the rate of income tax you pay when all your sources of income are added together. For example, if you take £20,000 from your pension, and you will receive the first £5,000 (25%) tax-free and the remaining £15,000 will be taxed as earned income. For a basic-rate taxpayer that equates to £3,000, leaving £17,000 net of tax. If you then deposit this into a savings account, you will receive interest on £17,000, rather than growth and dividends on £20,000, and the money will also form part of your estate for inheritance tax purposes.
Consider taking small pension pots as lump sums
For Defined Contribution pensions worth less than £10,000, you can take these amounts as small pot lump sums. A quarter is tax-free, and you pay income tax on the rest. You have to be over 55, and can do this up to 3 times. Taking a small pot does not trigger the Money Purchase Annual Allowance (MPAA) which restricts tax relief on your future pension contributions to £4,000 per year. It also doesn’t use up any of your lifetime allowance, currently £1.055 million.
Claim pension credit
Pension credit is a means-tested benefit for retired people on low incomes, and more than a million eligible people are not claiming it.
There are two components: Guarantee Credit and Savings Credit.
The Guarantee Credit tops up weekly income to a guaranteed minimum level, currently £167.25 for single people or £255.25 for couples.
The Savings Credit is an extra payment for people who saved some money towards their retirement.
Pensioners who do not claim Guarantee Credit are missing out on around £1,700 a year on average, while those eligible for Savings Credit are losing an average of £453 per year. You can only receive these benefits if you and your partner reached state pension age before 6 April 2016.
Consider how old you might live to
The average UK life expectancy is 80 for men and 83 for women. In all your pension decisions, you need to consider aspects of your life that can impact on your expected life expectancy and make sure you will have enough to last till you die.