Many of us know we should be doing more to save for our retirement. A lot of us, especially those who have taken a career break to raise a family, find there’s a shortfall when we check our pension savings.
So, while planning for your retirement should fill your mind with relaxing images of long walks and quality time with your grandchildren, for many the idea triggers anxiety.
Type “retirement” into Google and you’ll get almost 800 million results. There’s a lot of information – and misinformation – out there. But because retirement doesn’t come with an automatic one-size-fits-all solution you need to read between the lines to know what’s what.
Some retirement planning questions are situational, but others are commonly taken to be fact. So here are five retirement myths debunked.
1. Lifestyle pension funds that de-risk your investments aren’t in your interest
Pension funds that automatically de-risk your pension pot could leave you with less, not more.
Many pension plans provide this kind of fund. They work by investing more of your pension pot in company shares while you’re younger, but as you, near your retirement target date, the investment will be moved towards less risky assets, such as bonds or cash.
Most default pension funds are set up to work this way and are managed by the pension provider’s investment managers. But when your retirement income could need to last you 30 years, “de-risking” your pension could leave you with a shortfall in retirement income.
2. Using your pension to fund your retirement income isn’t the best strategy
If you have other investments, such as ISAs or general investment accounts (GIAs), you’re highly likely to find it more tax-efficient to draw an income from these funds before you touch your pension pot.
Draw income from your ISA and the money is free from Income Tax and Capital Gains Tax (CGT).
Draw from a GIA and the income can be treated as a capital gain, rather than income. The CGT allowance is £12,300 (2021/22) and if you are a couple this effectively doubles. Plus, if you don’t use it, you lose it. However, the Capital Gains Tax (CGT) annual exempt amount will fall from £12,300 to £6,000 in 2023, and to £3,000 in 2024 as per changes announced in the Autumn Statement.
Good planning can ensure you have the best possible level of tax-efficient income.
Leaving your pension pot untouched until you’ve exhausted other sources also means you could pass more wealth on to your heirs without incurring Inheritance Tax (IHT) charges.
If you want to leave some or all your pension savings and/or pension income to your dependants, make sure you complete an expression of wish form to assign who should inherit the cash or income. Fail to do this and your beneficiaries could end up having to pay unnecessary IHT.
3. Pensions aren’t as flexible as you think
Although pensions are the traditional route to save for retirement, in large part because of the government tax relief on contributions, they aren’t the only way to save. One of the biggest drawbacks is that they can be pretty inflexible when you’re ready to start using your pension savings for retirement income.
Another disadvantage of pension savings is the lack of access. Pension freedoms have improved things a bit, but you cannot access funds in your pension until you reach 55 (rising to 57 in 2028).
The 25% tax-free lump sum is nice to have, but after that, all income you take from your pension is liable to Income Tax at your marginal rate.
However, if you received tax relief as a higher- or additional-rate taxpayer, you might have benefited from up to 45% relief on your contributions. If you’re a basic-rate taxpayer once you retire, pensions are clearly a good way to save.
4. You don’t have to use your pension to buy an annuity to provide the income you want
Typically, unless you have a relatively small pension pot, buying an annuity to provide your income in retirement may not be the best approach.
An annuity offers low income for zero risk, while drawdown relies on investing in stocks.
Annuities give you a guaranteed income but, generally, pay less than you might receive through pension drawdown.
As with all market investments, fund performance can go down as well as up and the income you can achieve from drawdown is related to market performance, whereas an annuity locks your income in for life.
However, if you have a short life expectancy, an annuity may not be the best route. Although some annuities will pay out to a spouse, dying young may mean you lose out.
Which option is best for you will come down to factors such as your tolerance for risk and, perhaps, the amount of pension savings you have. There is the option to combine both annuity and drawdown, to give you peace of mind. We can help you understand whether drawdown, annuities or a combination of the two is the best option for you, based on your circumstances and income needs.
5. Holding too much cash isn’t always ideal
While we usually recommend clients hold between three- and six-months’ funds in an easy-access savings account, holding more than this could leave you exposed to the risk of inflation.
You’ll find lots of information about cashing in your pension savings and holding cash to avoid the risk of losing money on investments once you’re retired but holding too much cash is unhelpful.
While this anxiety is understandable, it’s helpful to take a step back and look at things rationally.
Yes, you’re going to retire but you may live another 30 years. That’s a long time to hold cash, and, more pertinently, a long time in which your money could continue to benefit from compound investment growth.
Sensible financial planning will help you balance your income requirements while still benefiting from potential investment gains.
With careful tax planning, you can remain invested, draw the income you need to maintain your desired lifestyle, and give yourself some protection from the effects of inflation.
None of this would be possible if you held all your funds in cash.
If you are interested in finding out more about how to plan for your retirement, please get in touch or read more here. Email us at email@example.com or call 020 7467 2700.
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