5 Mistakes Those Approaching Or At Retirement Make and How To Avoid Them

Introduction

Most people look forward to their retirement as a time to do all the things that they haven’t been able to do whist working, however, there are a number of mistakes that those approaching or at retirement make that could have an impact on their overall retirement planning.

In this article, we are going to look at some of these mistakes in more detail and look at ways to avoid them. I’m going to look at these through the lens of someone with a Workplace Pension or Personal Pension, someone looking to purchase an annuity and someone with Defined Benefit Pension Scheme. We’ll then look at a couple of mistakes common to all.

#1 - Workplace Pensions & Personal Pensions - Misunderstanding Risk

When people talk about risk it is usually in the context of investment risk which essentially means volatility. Volatility is generally seen as how much an investment can rise or fall over a given period relative to its average return. Most people will associate investment risk with potential falls in the market and hence falls in their overall pension fund or investment portfolio.

This concept can be seen in the default pension fund for most Workplace Pensions which will often contain a ‘life styling’ element. This means that as members get closer to their selected retirement age, their pension fund is moved to safer investments which typically means moving from equities to fixed income investments such as government or corporate bonds.

The idea behind this is that most people will want to take the maximum tax free cash from their pension fund and use the remainder to purchase an annuity so ‘life styling’ is a means to preserve the value of the pension fund at the time it is converted into a secure income.

However, many people are not going to buy an annuity and instead their pension fund is going to be used to draw down an income perhaps over the next 20 or 30 years.

This means that there are other risks that need to be taken into account and these include:

Inflation Risk

This is the risk that your assets are not growing in line with inflation. Most people are aware that, over the long term, if you hold your money in cash it will lose its purchasing power because interest rates on cash are generally lower than the rate of inflation. To achieve a rate of return in excess of cash necessitates a degree of risk.

The riskiest of the main asset classes (i.e. the one that can fluctuate the most) is generally equities, however, over the long-term equities generally produce the highest returns. Therefore it is important that there is a weighting to equities within your pension fund. The proportion allocated to equities will be dependent on your retirement objectives and your risk profile.

Those in the early part of retirement might find that their personal rate of inflation is higher than the standard measure of inflation. For example, there might be more travel, more eating out and more hobbies

Those grandparents funding grandchildren’s school fees might experience a higher rate of inflation as will those funding care home fees.

The difficulty that most retirees face is that they have to accept some equity risk, however, when markets fall, they lack the security of a regular salary and so will have to wait until markets recover.

The Risk of Running Out of Money

Working out how much money you can safely withdraw from your pension fund and other retirement assets is crucial to ensure that you don’t run out of money.

It is therefore important to stress-test your income and expenditure in retirement taking into account the lifestyle you want to live. In most cases, you want to spend more in the earlier part of retirement so that you can make the memories that you can look back fondly on in later life.

#2 – Annuity Purchase – Not Shopping Around

Over the last several years the insurance industry along with the Financial Conduct Authority (FCA) have publicised the need to shop around for an annuity but it is surprising how many people still don’t shop around. The difference between the best annuity rate and the worst can be significant.

According to the retirement specialist, Just Group, a healthy 75 year old can secure about 17% more income from the best annuity provider compared to the worst. At age 70, the gap is around 14% and at age 65 the gap is around 11%.

As people get older so the likelihood of them being in ill-health increases. Many medical conditions can trigger enhanced pension annuity rates and they include:

Diabetes
Asthma
Heart disease
High blood pressure
Cancer
Kidney failure
Smoking
Obesity

It is important that people shop around especially if they think they may qualify for an Enhanced Annuity.

#3 – Defined Benefits – Not Understanding Benefit Options

Defined Benefit schemes can be complex but it is important that you understand how the scheme works and what your options are at retirement.

If you are an active member of a Defined Benefit Scheme or a deferred member, the scheme administrator should send you an annual benefit statement which sets out the level of pension you have accrued within the scheme.

A common mistake is not to take into account the Early Retirement Factor when benefits are taken before the Normal Retirement Age. All Defined Benefit Schemes will have a Normal Retirement Age, for example, age 60 or 65, or, in the case of most public sector schemes, in line with the State Pension Age. Where benefits are taken before the Normal Retirement Age, an Early Retirement Factor is applied which can significantly reduce benefits.

It is therefore important to consider the impact of the Early Retirement Factor if your retirement plans don’t coincide with the Normal Retirement Age of the scheme.

Another common mistake is not to consider all of the options with regard to taking the tax free lump sum. Most private sector Defined Benefit Schemes will provide a commutation rate which is the amount of pension income being given up in exchange of taking the tax free lump sum.

When it comes to Defined Benefit Schemes, it is important to review your Annual Benefit Statement so that you know how much pension benefits you have accrued and to read the member booklet so that you have a good understanding of the options available to you at retirement.

#4 – Not Increasing Contributions

As we get older it is important that we increase our pension contributions especially when we receive pay increases. Too many people continue to pay the minimum amount into their pension and then forget about it.

Having an understanding of the level of income you might need in retirement is important and then, just as important, is having an understanding of whether you are on track to achieve that level of income.

Knowing this information several years before retirement is vital as it can provide sufficient time to make up any shortfall.

#5 – Not Having Something To Retire To

It can be easy to focus solely on the financial side of retirement but it is important to remember that money is a means to an end and not an end in itself. Money is important as it can provide the flexibility and financial freedom to enable you to do all the things you want to do in retirement but if you don’t know what your retirement looks like it can be a challenge.

It is important to consider what your purpose might be in retirement and how you are going to fill your days. For example, you might choose not to fully retire and instead work part-time for a few years. This might be in your existing career or you might choose to work in a completely different field.

You might consider returning to education or you might consider volunteering. You might take up a new hobby and reconnect with old friends. You might spend a good few months of the year travelling or watching your favourite sports team.

Those who spend time planning for their retirement both financially and non-financially tend to have healthier and happier retirements.

Conclusion

Retirement is one of the biggest milestones in our financial planning journey and it is one that we should spend several years planning for.

People often feel different emotions as they approach retirement; from anxiety to excitement. It can be psychologically challenging as you give up one sense of self, often defined by your job title, to find a different identity.

Having sufficient accumulated wealth, knowing your benefit options and having something to retire to are crucial for a long, healthy and happy retirement.