POT LUCK
Six mistakes that could reduce your pension pot by up to £300,000
Plus watch our video below on how to track down lost pensions
PENSIONS can seem daunting, but getting your savings on track is crucial to make sure you can afford to retire when you want to.
Generally, the earlier you start saving the easier it is because compound interest over time means that even modest amounts set aside can grow into huge sums.
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But other common life choices, such as going on maternity leave, moving to a part time job, and getting divorced can cost you hundreds of thousands of pounds from your pot.
The Institute and Faculty of Actuaries (IFoA) has carried out research that identifies the six key common life choices that can have a devastating effect on your retirement savings.
The IFoA has then used actuarial modelling techniques to show exactly how costly each mistake can be.
Kartina Tahir Thomson, IFoA president, said: “The numbers presented in this report are stark. When we are making some of the biggest decisions in our lives, it is worrying that so much is at stake.
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“On top of this, many people are unaware of the hidden costs of their decisions that may not impact them until years later, during what could be considered the most vulnerable years of their life.”
The good news is, that there are things you can do to prevent these decisions from impacting your financial future.
Here are the six life moments where it’s important to think about your pension, and how much you’ll miss out on if you don’t.
Not starting a pension - £300,000
Starting a pension as early as possible is one of the most important things you can do, and even small gaps can have a significant impact on your savings.
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For instance, the IFoA estimates that for a young saver, starting a pension at age 35 instead of 25 could mean their pot is only £500,000 at retirement instead of £800,000.
If you start saving even earlier, for instance, from your very first job, your money grows even further.
What to do if you have two pensions
To avoid these gaps, you should make sure you start saving into a pension as soon as you begin to earn, even if you’re not eligible for auto-enrolment.
Anyone aged over 22 who earns over £10,000 from a single employer should be automatically put into their company pension scheme.
However, there are plenty of people who aren’t automatically eligible because they are younger than that, don’t earn enough or are self-employed.
It could even be that you’re over the age limit and your income is higher than £10k, but because you have multiple employers you don’t meet the £10k threshold for each individual job.
However, just because you’re not automatically enrolled, it doesn’t mean you can’t join the pension scheme. Anyone can ask to sign up and you’ll get tax relief from the government, which helps to boost your pension.
WHAT IS PENSION AUTO-ENROLMENT
The government introduced auto-enrolment in 2012 as a way of helping to boost workers' pensions.
Before then, the responsibility of joining a workplace pension was on the employee.
Under the scheme, employers have to automatically enrol you into a workplace pension scheme and make monthly contributions.
You also make contributions yourself.
But to be in the scheme you have to be over 22 and under the state pension age.
Plus, you have to be earning at least £10,000 a year.
Your bosses should write to you when you've been automatically enrolled.
A minimum of 8% has to be paid into the pension, with you contributing 5% and your employer paying at least 3%.
Crucially, the contribution you make as an employee is deducted before tax - so the actual amount you're putting away is less than it sounds.
As an example, if you pay 20% tax on your earnings, and your pension contribution is £80, this actually only costs you £64.
If you earn less than £10,000, but more than £6,240, your employer will have to put money into your retirement fund too.
If you’re self-employed, look into setting up a SIPP and contributing to that. You’ll also get tax relief top-ups on what you save.
Opting out of a pension - £100,000
When you are auto-enrolled into a pension, you’re given the option to opt-out, but this can be extremely costly.
The IFoA estimates that opting out for just five years will reduce the average pension pot by £100,000.
Of course, being in the pension scheme means that money will be deducted from your salary, but you’ll also get tax relief from the government and a contribution from your employer.
And opting in from the start can set you on the right track to have enough to retire on.
Not taking advantage of extra employer contributions - £100,000
Some more generous employers offer something called “matching” where they agree to put extra money into your pension (above the auto-enrolment legal minimums) if you do too - up to a certain limit.
The IFoA calculates that for a typical person, not taking advantage of extra contributions of 1% of their salary for 40 years could result in up to £100,000 lost from the final pension pot.
On top of that, you’re basically turning down free money from your bosses.
Many employers will let you match for more than 1%, which means you could benefit from a much bigger boost.
For instance, a match of 4% could net you £400,000 more in your pension once the employer contributions, tax relief, and investment returns are factored in.
Speak to your HR department or pension provider to see whether matching is available at your firm.
Six months maternity leave - £30,000
The IFoA says that six months of maternity leave could reduce a pension pot by £30k or more.
If you have multiple children or take longer leave, the impacts could be much more severe, which is just one of the reasons that women typically have much smaller pension pots than men.
The issue here is that your contributions are typically based on your income, and many women are on statutory maternity pay or maternity allowance.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) - This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension - The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won't be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension - This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you'll be paid a set amount each year upon retiring. It's often referred to as a gold-plated pension or a defined benefit (DB) pension. But they're not typically offered by employers anymore.
- New state pension - This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you'll need 35 years of National Insurance contributions to get this. You also need at least ten years' worth to qualify for anything at all.
- Basic state pension - If you reach the state pension age on or before April 2016, you'll get the basic state pension. The full amount is £156.20 per week and you'll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what's known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.
Even women who work for employers with more generous maternity benefits often take an income hit if they stay off work for a full year.
You’re allowed to overpay your pension (as long as you don’t exceed the annual allowance of £60,000 or your total income), so it’s important to sit down as a family and crunch the numbers.
If you can overpay to the same level as before you went on leave, you’ll avoid the impact on your overall retirement fund.
Of course, the early baby years are expensive, and not everyone can afford to overpay, but make sure you’re having those conversations and looking at the whole family finances and what it means for the future.
Getting divorced – amount depends on circumstances
Pensions are often one of the top two biggest assets in a marriage, so it’s crucial you take them into account when you divorce.
If either party has a defined benefit pension, it could even be worth more than the house.
Make sure that when you’re making decisions around finances that you fully understand the pensions picture, and that it is factored into any agreement.
Moving from full-time to part-time work - £200,000
There are many considerations when it comes to moving from full-time work to part-time work but often pensions get forgotten.
Because your contributions are normally calculated as a percentage of pay, reducing your hours could have a significant impact on your retirement pot.
For example, the IFoA calculates that an average employee choosing to work three days a week for the last 25 years of their career would be paying in 40% less pension contributions and this could reduce their pension by £200k at retirement.
According to the ONS, ‘Labour Force Survey’ 1.7 million men and 5.1 million women are employed part-time workers in the UK.
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When thinking about going part-time, make sure you’re including pensions in your calculations.
Think about whether you’ll be able to afford to voluntarily overpay so that you are putting in as much as when you were full time.
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