The top 2 pension mistakes your clients could make, and how we can help

Retirement is an important milestone that your clients are likely looking forward to – but without robust financial plans in place, it could be difficult to make their later-life income last.

The “minimum cost of retirement” surged by 18% in 2022, according to data published by Money Marketing – and alongside this increase in cost, life expectancy is rising. The Office for National Statistics (ONS) reports that life expectancy between 2018 and 2020 rose to 79 for men and 82.9 years for women.

All this points to one crucial truth: your clients may need to make their retirement income stretch further than they previously thought.

Unfortunately, there are some key pension mistakes that individuals make again and again – both before and during their retirement. What’s more, your clients could be repeating these costly mistakes without even knowing about it.

In a time where retirees may not be able to afford the luxury of error, learning about these mistakes before they stop working could be very valuable.

Here are the top two pension mistakes your clients could make, and how to avoid them.

1. Underestimating the value of workplace pension contributions

If your clients are still on the runway to retirement, it’s vital that they do not underestimate the value of workplace pension contributions.

Making as many contributions as they can afford in the years leading up to retirement could give their pension the boost it needs to go the distance.

Indeed, maximising contributions within the Annual Allowance, which stands at £60,000 as of the 2023/24 tax year, could enable your clients to keep growing their pension pot right up until the point at which they draw it.

Plus, it’s important to remember that once they make a contribution, many employers will match it, essentially doubling the value added to the pot each time.

While matching contributions is not a requirement – the minimum contribution of qualifying earnings is 8%, 3% of which must be paid by the employer – businesses often offer matched contributions as a workplace benefit, especially for high earners.

What’s more, your clients are likely to receive tax relief on the earnings they direct into their pension pot. If they are a basic-rate taxpayer, this tax relief will be added automatically; higher- and additional-rate taxpayers should claim the extra relief they receive through self-assessment.

Importantly, underestimating the value of pension contributions during their career could damage your clients’ financial viability later on.

This can be seen in an AJ Bell study, which showed the long-term impact of pausing or reducing contributions during the cost of living crisis. The study showed that if a 30-year-old earning £30,000 a year and paying 8% into their pension paused their contributions for three years, they could be left with a £15,000 shortfall by the time they reach State Pension Age.

Sadly, PensionsAge reports that one-quarter of savers “have stopped or were planning to stop” pension contributions while the cost of living rises.

Although your clients could be older than the example used by AJ Bell, it’s essential for them to understand just how important pension contributions are, and to learn how underestimating them could leave them with less wealth in retirement.

2. Taking their pension tax-inefficiently

There is another key pension trap your clients could fall into: taking their pension tax-inefficiently. When the time comes for your clients to retire, they will be faced with an important decision about how they draw money from their pension.

There are two key methods of drawdown: flexi-access, and drawing your pension as a lump sum.

Flexi-access is usually a more tax-efficient way to draw from a pension. After taking the 25% tax-free amount, your client can take income in smaller chunks from their pot, meaning that they could pay less Income Tax on the amount they take each time.

Whereas, a lump sum withdrawal can lead to a higher Income Tax bill, because the amount taken above the 25% tax-free amount is usually subject to their marginal rate. If your client has a large pot, this might mean they pay 45% of this sum as additional-rate Income Tax.

Sadly, according to Standard Life, 43% of over-55s are unaware that you can take 25% of your defined contribution (DC) pension tax-free.

What’s more, the Financial Conduct Authority (FCA) report that in 2021/22, the number of pension holders taking their entire pension as a lump sum jumped by 28% compared to the previous year.

Both these examples signify a lack of awareness surrounding pensions and tax that could lead your clients to make costly mistakes with their retirement income.

Fortunately, working with a financial planner can make all the difference at every stage of your clients’ careers and retirement. With our expertise to hand, they could make confident decisions before and during retirement that may give them the financial freedom they deserve later in life.

Get in touch

We’re here to advise you and your clients on all aspects of financial planning. If you have clients that would benefit from pension advice, email enquiries@prosserknowles.co.uk or call 01905 619 100.

Please note

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.

All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.