8 common pension mistakes, and how to avoid them

Mistakes happen. We’re all human, and human error is natural. Maybe your attention wanders or you forget you’re supposed to press button B rather than button A.

My view is that you take it on the chin and make sure you avoid making such a mistake again.

I’m probably not quite as philosophical when it comes to financial mistakes – especially easily avoidable ones. Simple mistakes that cost my clients money, and that wouldn’t have happened with some straightforward planning, can be a frustration!

Take your pension fund, for example.

You’ve done all the hard work. You’re diligently saving throughout your working life, building up a sizeable pension fund that’ll mean you can enjoy a good quality of life when you retire – and one simple error ends up costing you thousands.

I’ve listed eight common pension mistakes here. All of them are easily avoidable with some straightforward planning.

1. Taking money from your pension to use as “rainy day money”

It’s perfectly understandable to want a savings pot. “Rainy day money”, if you will – a sum set aside for emergencies and unexpected events.

However, taking it out of your tax-efficient pension fund is rarely the best way to generate one.

There are three reasons for this:

• Unless you’re taking it from your 25% tax-free entitlement, it will be taxed as income.
• Once you’ve taken it out, it’s no longer getting investment growth.
• By “crystallising” it – that is, moving it out of a pension vehicle – you’re potentially making it subject to Inheritance Tax (IHT) when you die.

In a nutshell, you’re typically better off using your pension fund for income and creating your savings pot from other sources.

2. Taking retirement income from the wrong source

Your pension fund is designed to provide you with income in retirement. But, even if you are taking money out as income, it might not be the right thing to do.

There may be times when you might be better off using your other savings, which aren’t growing as tax-efficiently as money in a pension fund, to provide you with income.

These other sources could include savings, ISAs, stocks and shares, and cash.

If you’re in the position of needing income just after a market downturn, the best source for this may often be a low-interest savings account rather than your pension fund. If you’re selling investments to buy an income when markets are low, you’ll have to sell more to provide the same amount of income.

So, taking income from savings (even the “rainy day money” we referenced earlier) could give your investments time to recover.

3. There is such a thing as too much income

Another common mistake that can leave you paying tax unnecessarily, is taking more income from your pension than you need. Just because you can take money from your fund when you reach 55 (rising to 57 in 2028), it doesn’t mean you have to.

Anything you take more than your tax-free entitlement will be taxed as income – and it will be taxed at your marginal rate. That also includes your State Pension.

If you’re married, or in a civil partnership, remember both of you have a Personal Allowance and will be subject to the same tax bands. So, it can pay to plan how you take your income so that you’re paying as little higher- or additional-rate tax as possible.

4. Not being tax-year savvy – what a difference a day makes!

This is a really simple one.

If you’re looking at taking income from your pension fund around the end of the tax year (5 April) and you’re either already paying higher- or additional-rate tax, or it will take you into either of those brackets, then it probably makes sense not to.

It can be far better to wait what could only be a few days for the new tax year to start. This will give you a chance to plan your income in the new tax year, and potentially avoid paying more tax than you have to.

5. Exceeding the Annual Allowance

Another common mistake is exceeding your Annual Allowance. This is the maximum you’re allowed to contribute tax-efficiently into your pension arrangements.

The current allowance is £40,000 (or 100% of your earnings if lower). Given that the government automatically add 20% tax relief to all your personal contributions, the maximum you can physically pay in is £32,000 each year.

This is potentially easy to do. For example, the Annual Allowance includes contributions paid by your employer, so it would be easy to overlook that amount when paying in a single contribution and find yourself subject to an avoidable tax charge.

Any excess in your personal contributions will be treated as earned income, so you’ll pay tax on it at your marginal rate.

You should also be aware that, if you earn more than £240,000, the Tapered Annual Allowance will reduce the amount you can contribute.

There are ways to pay more than your Annual Allowance by “carrying forward” any unused allowance from previous tax years. It’s a relatively straightforward process that I can help you with.

6. Exceeding the Money Purchase Annual Allowance

The Annual Allowance is reduced from £40,000 to just £4,000 if you’ve taken any money from your pension fund in excess of your 25% tax-free entitlement.

So, if you’re thinking of taking money from your pension pot while you’re still working (and still contributing) you could be shooting yourself in the foot if you end up reducing the amount you can save – especially when you consider just how tax-efficient saving into a pension is.

7. Exceeding the Lifetime Allowance

The Lifetime Allowance is a limit on the total amount you can take from your pension schemes – whether lump sums or retirement income. If you exceed it, you’ll trigger a tax charge on the excess, which can be as high as 55%.

The current Lifetime Allowance is £1,073,100 and the chancellor recently fixed this allowance at this level until 2026. Each time you take income or lump sums from your pot, it’s tested against the allowance.

Again, it’s a potentially costly mistake you can easily avoid by planning ahead.

8. Not checking your State Pension

At £9,339 a year, the current State Pension is probably not enough to live comfortably on, but it’s guaranteed for life and increases in line with inflation each year.

I tend it see it as a handy, guaranteed income underpin for your retirement – maybe enough to pay your utility bills and food shopping.

The amount you get is based on your National Insurance contributions (NICs) history, so the mistake here is not checking your entitlement. There is even a government website where you can check.

By checking, you’ll know if you have gaps in your NICs history – maybe if you were working abroad. You may be able to “buy” extra years’ worth of NICs entitlement and therefore increase the guaranteed income you’ll receive.

Get in touch

To find out more about how to avoid the simple mistakes I’ve identified here, please give me a call on 07769 156 250.

Please note

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

 

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The Financial Conduct Authority does not regulate taxation & Trust advice

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.