5 frightening pension nightmares to avoid this Halloween

Halloween approaches and, for many of us, October is the month to enjoy carving pumpkins and dressing up in terrifying costumes. But, while you might enjoy a good scare from your favourite horror movie, you don’t want any nasty surprises when it comes to your pension. 

Whether you are still a long way from retirement or you have started drawing from your pension already, there are some common mistakes that could have far-reaching effects on your savings.

So, as you celebrate all things scary, make sure that you avoid these five frightening pension nightmares this Halloween.

1. Using your pension as a “rainy day” fund

The cost of living crisis has dominated headlines over the last few years and many people are feeling the effects of increased food and fuel costs, and rising energy bills.

While it has fallen recently, inflation was still 6.7% in the 12 months to September 2023, according to the Office for National Statistics (ONS). As such, it is likely that your household expenses will continue to rise in the near future.

If you are aged 55 or over and you have access to your pension, you may decide to take money from it to help cover some of these increased living costs. However, unless it is absolutely necessary, you may want to avoid this for several reasons.

First, when you take that money from your pension, it is no longer exposed to potential growth. As a result, your pension pot may be considerably smaller when you come to retire.

Additionally, unless it is part of your 25% tax-free entitlement, any withdrawals will be taxed as income. 

You may also trigger the Money Purchase Annual Allowance (MPAA) if you draw flexibly from a defined contribution (DC) pension. This could reduce the amount of wealth you can build in your pension tax-efficiently – more on this later.

Consequently, taking money from your pension prematurely could make it harder to reach your retirement savings goals. You may find it easier to stay on track if you use wealth from other sources, such as a cash savings account, to cover increased living costs instead.

2. Not considering how your pension funds are invested

One of the main benefits of saving money in a pension is that your provider invests the money. This means your savings potentially grow over time, giving you a healthy retirement fund to draw from later in life.

To achieve this, you may need to consider the level of risk that you expose your pension to, and whether it is suitable for your goals.

If you still have decades before you retire, for instance, your investments likely have time to recover from a period of uncertainty. As such, you may want to expose yourself to a higher level of risk so you can potentially see more growth.

Conversely, if you are only a few years from retirement, you may decide to favour low-risk investments.

It is also important to note that some pension funds perform better than others, so you could see higher returns if you are more proactive and regularly review your pots. Unfortunately, many people do not take an active interest in where their savings are invested. 

Indeed, according to This is Money, 97% of people leave their pension savings in the default fund, even though they may have the option to move them.

Working with a financial planner to consider how your pension is invested can help you to progress towards your retirement savings goals.

3. Failing to claim additional tax relief

The tax relief that you receive on pension contributions gives your savings a significant boost. When you pay into your pension, you usually automatically receive 20% tax relief on your contribution.

This means a £100 contribution effectively “costs” you £80. However, if you are in a higher tax bracket, you may be able to claim more tax relief.

Tax relief is applied at your marginal rate of Income Tax, so if you are an additional- or higher-rate taxpayer, you may be entitled to a total of 40% or 45% tax relief respectively. 

You must claim the additional 20% or 25% tax relief through self-assessment but many people fail to do this. According to Money Week, high earners missed out on £1.3 billion in unclaimed tax relief between 2016/2017 and 2020/2021.

If you are a higher- or additional-rate taxpayer, you may need to check that you have received all the tax relief you are entitled to.

4. Not understanding which Annual Allowance applies to you

Your Annual Allowance is the amount that you can accumulate in your pension each year without additional tax charges. 

In the 2023/2024 tax year, the Annual Allowance is £60,000 and this includes your own contributions, employer contributions, and tax relief.

However, in some circumstances, a different Annual Allowance may apply.

For example, you will likely trigger the MPAA when you start drawing flexibly from a DC pension. This effectively reduces your Annual Allowance to £10,000 in the 2023/2024 tax year.

Alternatively, you may be affected by the Tapered Annual Allowance if your earnings exceed a threshold income – including your salary, pension contributions, and other taxable income – of £200,000.

Once you trigger the Tapered Annual Allowance, your Annual Allowance is reduced by £1 for every £2 that you exceed the adjusted income of £260,000 – this is the same as your threshold income but also includes employer pension contributions. In the 2023/2024 tax year, your Annual Allowance can fall to a minimum of £10,000 in this way.

Failing to realise that you have triggered the MPAA or the Tapered Annual Allowance could mean that you exceed your Annual Allowance without knowing. 

Consequently, you may pay significantly more tax than you expected, and it may be more difficult to build your retirement savings tax-efficiently.

5. Taking more than you need from your pension

Taking more than you need from your pension is a common mistake because it could mean that you pay more tax and miss out on potential growth.

While you can start taking money from your pension when you reach the Minimum Pension Age of 55 (rising to 57 in 2028), it is normally only sensible to do so if you need the money to fund your lifestyle.

Otherwise, it may be beneficial to leave funds in your pension because they are taxed as income when you withdraw them. You can take 25% of your pension as a tax-free lump sum but anything beyond this is taxed at your marginal rate of Income Tax.

Fortunately, if you rely on wealth from other sources first, and only draw what you need from your pension, it may be easier to stay in a lower tax band and reduce the Income Tax you pay.

Additionally, any wealth left in your pension remains invested and may continue to grow over time.

Head to this useful article to find out more about paying tax on your pension income.

Get in touch

We can help you avoid any frightening retirement planning mistakes this Halloween.

Please contact us at hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that we’re a bona fide company providing excellent advice and high-quality service.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

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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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