3 common mistakes DIY retirees make that you need to avoid

According to data from the Financial Conduct Authority reported by Money Marketing, more retirees are flexibly accessing their pension pot without professional advice. In 2021, 40% of decumulation solutions – flexi-access drawdown and similar – were purchased without the help of a financial planner.

This is the highest number of non-advised solutions since the Pension Freedoms legislation came into force in 2015. It makes for worrying reading, as DIY retirees could pay more taxes than they need to and might put their retirement lifestyle at risk.

If you’re considering accessing your retirement fund without advice, discover three common mistakes you’ll probably want to avoid, and how a financial planner can ensure that you do.

1. Paying too much tax

An article by Unbiased in March 2022 makes for sobering reading. It revealed that HM Revenue & Customs received around £2 billion more than anticipated because pensioners accessed their retirement pot in a way that generated an unexpected tax charge.

There are several ways DIY retirees might do this, which include:

  • Taking high levels of income or one-off payments that push you into a higher tax bracket.
  • Falling foul of the Money Purchase Annual Allowance (MPAA), which could affect you if you’re drawing a flexible pension while still working. The little-known tax trap could slash your Annual Allowance to just £4,000 a year in 2022/23. As the allowance is the amount of tax relief you receive on pension contributions, triggering the MPAA may mean you pay tax charges on some of the money you put into your pension pot.
  • Exceeding the Lifetime Allowance (LTA), which might result in a tax charge of 55% if you access more than 25% of your pension as a lump sum. While the LTA stands at £1,073,100 in 2022/23, which is a significant amount of money, the potential for your pension to exceed this may be greater than you think.

Speaking with a financial planner could help you to avoid paying more tax on your pension income than is necessary. One way a planner might be able to achieve this, for example, is by using an uncrystallised funds pension lump sum (UFPLS).

This is where you could take the tax-free element of your pension as part of your income, which could significantly reduce, or even negate, the amount of Income Tax you pay.

2. Depleting your pension pot

When you reach your planned retirement age it’s vital to understand the level of income your pension pot will provide you without the risk of it running out too early.

If you do deplete your fund too quickly, it is likely to result in you having to significantly reduce your lifestyle in retirement, resulting in anxiety and stress when you should be enjoying life.

A financial planner can use sophisticated income modelling software to confirm how much your pension could provide and how long it might last. They will also confirm whether drawing flexible income or opting for an annuity, which provides an income for life, is the best strategy for you.

If your pension cannot provide the level of income you’d hoped for, a planner can also provide you with options, such as retiring later or adjusting your standard of living in retirement.

3. Reducing your pension’s spending power

According to a recent MoneyAge report, fewer than 4 in 10 of over-55s factor inflation into their retirement plans. And yet, the effects of inflation on your pension pot could be huge.

Inflation is the rising price of goods and services, which has the potential to reduce your pension’s value in real terms over the long term.

To demonstrate this, you may want to consider the following.

If you use an inflation calculator, you’ll see that you need £141 today to have the same spending power as £100 in July 2012. This means your pension pot would have needed to grow by around 41% in the past 10 years to keep pace with an average inflation rate of 3.5%.

This is significantly lower than June’s inflation rate, which the Office for National Statistics revealed was 9.4%.

Ensuring that your pension has adequate inflation-proofing is a vital part of your retirement strategy.

A financial planner can help you to reduce the effects of inflation on your pension, such as adjusting the level of risk your retirement fund’s exposed to. As growth typically comes from the higher-risk assets within your pension investment, increasing its level of risk could boost its growth potential and help inflation-proof it.

That said, always speak to a financial planner before adjusting the level of risk your pension is exposed to. A planner will confirm whether it’s the right strategy for you, and ensure that you understand the implications of doing so.

Get in touch

If you’d like to discuss accessing your pension pot if you’re approaching retirement, or want to ensure the income you’re taking is as tax-efficient as possible, please contact us on hello@ardentuk.com or call 01904 655 330.

As we’re an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can have peace of mind that you will receive excellent advice and the highest quality service.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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By talking about your current situation and listening to your aims, we create a personalised plan that will put you on a path to achieving your aspirations.

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