The thought of life without a regular salary can be daunting, and there are a number of pitfalls to look out for when retirement is just around the corner. Careful planning and sound advice will help to avoid problems and lead to a secure and happy future for you and your loved ones. Here are a few points to bear in mind.
Go easy on the lump sum
Recent legislation has dramatically changed the way that private pensions work. Since April 2015, you’re free to spend or re-invest your pension funds as you see fit, rather than being obliged to purchase an annuity.
If you wish to take the whole pot as a lump sum, there’s nothing to stop you. This may sound exciting if you’re thinking of going on a dream holiday or buying the luxury car you’ve always wanted, but without sensible planning your funds will dwindle at an alarming rate in the absence of regular income.
Watch out for income tax
Money held within a pension fund is allowed to grow in a very efficient way as neither capital growth or dividends are taxed. As soon as funds are removed from the pension wrapper, income tax applies to 75% of the total withdrawn. That’s a considerable amount to lose even if your pot is substantial. Whether you take a lump sum or smaller amounts over time, the same percentage of deductions applies with every payment.
Private funds can be accessed when you’re 55 but at this age most people are still working. Don’t be tempted to dip into your pension at this point. You’ll lose far more than you gain, as this will be added to your salary and income tax will be calculated on the total sum. You’ll find yourself in a higher tax band, which is hardly an ideal way of obtaining extra money. If you really need additional income at this time, it’s best to use other savings if at all possible and leave your pension pot to accumulate.
Don’t underestimate the timescale
High standards of living and healthcare improvements mean you have a good chance of reaching a ripe old age. Your funds need to last as long as you do. Depending on when you finally stop working you could be looking at a period of 25 years or more to live on pensions and savings.
A degree of forethought is vital, and not just for everyday expenses. You may need funds for medical costs or residential care as you get older. No one wants to consider these possibilities but preparing for them in advance will prevent a great deal of worry in the future. It’s also worth remembering that the same will apply to your parents, so relying on receiving an inheritance in due course could also be unwise.
Avoid assumptions about property
Many people rely on profit from property to supplement their pensions and assume the payback from downsizing or rental income will be substantial. This certainly can be the case and it’s fine to have property as part of your portfolio. However as prices tend to fluctuate considerably and returns can’t be guaranteed, it’s unwise to presuppose that property will cover all your financial requirements.
Hang on to final salary schemes
In order to reduce costs, some companies are offering employees lump sums to transfer out of these schemes. Although final salary pensions are fast becoming a thing of the past, existing plans are sure to pay out unless a company goes out of business. As the amount is based on length of scheme membership and salary at retirement, these pensions are usually very generous. Don’t make the mistake of grabbing a large cash payout now, because you’ll certainly be missing out later.
Pension pitfalls: what to avoid? The biggest pitfall of all
The biggest pitfall when it comes to pension planning and your retirement is to do nothing. Whatever your resources they need to be handled correctly, even if they’re substantial. Mismanagement will expose your funds to high levels of tax and an alarming shortfall will quickly follow, so you can’t afford to be complacent. The State Pension will always be there to supplement your income, but at around £150.00 per week (depending on your National Insurance contributions) this is more of a top up than a solution if things go wrong.
Our advisors will help you plan for a comfortable and fulfilling retirement, and keep an eye on you in the years to come.
Pension pitfalls: what to avoid? To find out more, call Cotswold Financial Planning today on 01608 651608 or contact us here.