11 dos and don’ts in pension planning

How to maximise your pension by sidestepping principal pitfalls.

The majority of us now know not to just accept the annuity we are offered but to instead shop around for the best option available and pay attention to pension charges. However, sadly, there are many other pension planning mistakes that can prove very expensive in the long run.

Here’s a checklist of the principal pitfalls to help you avoid them.

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1) Do claim child benefit

Many mothers are losing state pension by not claiming child benefit. Claiming for a dependant under 12 gives you a national insurance (NI) credit towards the ‘qualifying years’ required for the state pension, even if you are not employed. Each ‘qualifying year’ is equal to £231 a year in state pension. The credit goes to only one parent, sensibly the lower earner or the one who is not working (because the higher earner is in paid work and paying national insurance, so does not need the credit towards their pension).

The problem has arisen because a rule change in 2013 stipulated that anyone earning over £50,000 a year loses some of the family’s entitlement to child benefit, so many couples stopped claiming. However, around 200,000 couples could benefit because the lower-paid spouse is not accruing the pension credits they are entitled to for looking after a child. You can remedy this by transferring the credit to your spouse, even historically. Complete form CF411a (on the gov.uk website).

2) Don’t opt out of your company pension

All employers must now pay at least 3% of an employee’s salary into a pension scheme, so opting out of your workplace pension means forgoing thousands of pounds of free money. Many companies even match employee contributions, often up to 6% or 8%. For example, any scheme with the Pension Quality Mark (PQM) accreditation must have total contributions of 10%, of which at least 6% is paid by the employer.

Employers that provide salary-related pension schemes effectively make even more generous contributions of 15% or more, to be able to meet their benefits promise. If you have already left your employer’s scheme, you can opt in again by speaking to HR. Your employer is also required to automatically enrol you back into the scheme three years after you opted out, provided you meet the eligibility criteria.

3) Do check your workplace pension is using your correct retirement age

Many workplace defined contribution (DC) pension schemes have a default fund that de-risks as you get closer to retirement age, switching out of equities and into more conservative investments such as bonds and cash, five or even 10 years ahead of the big day. This is designed to prevent big drops just before you retire.

Aviva found that an employee earning £27,664 and automatically enrolled in a workplace pension since age 22 would enjoy a fund value of £137,600 if their retirement age was set to 68, but the impact of switching to low-risk investments earlier would have produced only £127,700 if their pension age was recorded as 60. Check with your pension provider what age it has you down for; if it’s wrong, you can easily get it changed.

4) Do consider alternatives to the default fund

If you’re intending to move your pension into drawdown and take an income directly from your DC investment pot when you retire (as opposed to using the money to buy an annuity), it’s not a great idea to de-risk in a default fund as you approach retirement age, as you’ll need to maintain equity exposure to generate that income. Your pension scheme will offer alternatives to the default option and you can switch into one of those.

5) Don’t be too cautious in your investment choice

People frequently take an overly cautious approach towards their investments, but the long investment horizon until retirement – of perhaps 20, 30 or even 40 years – makes investing in low-risk assets the worst thing they can do. According to Aegon, a £200,000 investment over 20 years in a “cautious asset mix” portfolio generated returns of just £249,068, compared with £342,126 in a “more adventurous asset mix”.

6) Do think about who you want to inherit your pension

Many people have not changed their beneficiary in their employer’s pension scheme since they were first asked to complete paperwork on joining the scheme, perhaps decades ago.

According to Royal London, over three-quarters of a million people aged between 55 and 64 who had remarried by the age of 50 have out-of-date paperwork and are at risk of passing their pension pot on to an ex-partner on their death. If someone nominates their spouse, but later divorces and fails to update this paperwork, the scheme’s trustees may be obliged to respect the recorded wishes.

Ask for an expression of wish form or beneficiary form, which will only take a minute to complete but could avoid all kinds of disputes when you are gone.

7) Do consolidate pensions from previous employments

Consolidating pension pots from previous employments into one flexible pension account is usually cheaper to administer and easier to understand, with a single balance that you can check any time.

Consolidation allows you to take your savings out of ‘legacy’ defined contribution schemes, where the charges are often penal and the investment record poor, and switch to a more modern plan with a wider range of investment options, including lower-cost funds. Older pension schemes are also unlikely to offer flexible ways to access your money at retirement.

There are two scenarios where consolidation may not be beneficial, however. The first is if a legacy scheme offers a guaranteed annuity rate. These can be nearly double rates on the open market. The second is where a legacy pension allows you to take out more than the usual 25% of that particular pension tax-free – in some cases as much as 75% was permitted.

8) Don’t withdraw cash simply to put it in the bank

You can now take pension cash from age 55, but typically it is not wise to do so until you have retired, particularly if all you intend to do is pay it into your bank account or other savings. This could result in you paying too much tax, as well as missing out on the benefits of your pot remaining invested.

The first 25% withdrawn from a pension is tax-free, but the remainder is taxed at your ‘marginal’ rate – the rate of income tax you pay when all your sources of income are added together. For example, if you take £20,000 from your pension, you’ll receive the first £5,000 (25%) tax-free and the remaining £15,000 will be taxed as earned income. For a basic-rate taxpayer that amounts to £3,000, leaving £17,000 net of tax. If you then deposit this into a savings account, you’ll receive interest on £17,000, rather than growth and dividends on £20,000, and the money will also form part of your estate for inheritance tax purposes.

9) Do consider taking small pension pots as lump sums

For DC pensions worth less than £10,000, another option is to take these amounts as “small pot lump sums”. As usual, a quarter is tax-free, and you pay income tax on the rest. You have to be over 55, and can do this up to three times. Taking a small pot does not trigger the Money Purchase Annual Allowance (MPAA) which restricts tax relief on your future pension contributions to £4,000 per year. It also doesn’t use up any of your lifetime allowance, currently £1.055 million.

10) Do claim pension credit

Pension credit is a means-tested benefit for retired people on low incomes, and more than a million eligible people aren’t claiming it. There are two elements: Guarantee Credit and Savings Credit. The Guarantee Credit tops up weekly income to a guaranteed minimum level, currently £167.25 for single people or £255.25 for couples. The Savings Credit is an extra payment for people who saved some money towards their retirement.

Pensioners who don’t claim Guarantee Credit are missing out on around £1,700 a year on average, while those eligible for Savings Credit are losing an average of £453 per year. You can only receive these benefits if you (and your partner) reached state pension age before 6 April 2016. Call 0800 99 1234 to claim. You can backdate it for three months.

11) Don’t discount how old you might live to be

The average UK life expectancy is 80 for men and 83 for women. In all pension decisions, it helps to know what you are dealing with. The government’s online life expectancy calculator, available on ons.gov.uk, should give you a steer.