Alanna Petroff: There are many pension traps that you can fall into when you’re trying to save for retirement and we're going to review six main pension traps today. The first is not paying enough into your pension; second, not claiming tax relief; third, not using your company pension; the fourth is not understanding risk; the fifth is paying too much into your pension at a young age; and the sixth is not understanding pension rules.
So I'm joined today by AJ Bell's Pension Expert and Retirement Expert, Mike Morrison, and we're going to talk about these six key pension traps. So Mike, let's go over the first one, that's not paying enough into your pension.
Mike Morrison: I think the key issue Alanna here is that, you need to pay sufficient to get a reasonable income out and if you think you're paying some, but it is not enough, you'll end up with a small fund at the end and it won't be sufficient to meet your needs. So understand what you need and work backwards.
Petroff: Okay. And the second trap is not claiming tax relief. How does this work exactly?
Morrison: I think this is a key for high rate tax payers. Most pension schemes will give an allowance for basic rate tax relief on the contributions, but high rate tax payers actually have to reclaim their high rate tax relief through their tax return each year. And statistics have shown that a high percentage of people don’t actually get around to it. It could be worth up to I think something like £1,200 a year.
Petroff: Okay. That's pretty significant then. And then what about for people that might have SIPPs, but they are working within a company that offers a pension plan. How is that a problem?
Morrison: For me the key there is to consider the pension contribution that your employer might make. Will he make it to the SIPP for you? Or will he only make it to the company pension scheme? Because if you then don't join the company pension scheme, you are not getting that contribution. To put it mildly, in a way, you are turning down a salary increase.
Petroff: Because many companies do have the pension contribution matching.
Morrison: Exactly. So make sure you understand that and get into the right scheme where your money does more for you.
Petroff: And what about not understanding risk? How does that work exactly with your pension?
Morrison: A pension is about building a fund for retirement and you have got to get from A to B and getting from A to B in a way that you are comfortable with. In your 20s, you may have 40 years to go to retirement, perhaps you can afford to take more risk and choose equity investments. At a later age, you’ve got a shorter period of time where volatility could really affect your retirement, perhaps you need to be a bit more cautious. Perhaps you need to look at lifestyle in your investments. So I think considering risk, understanding it, making sure what you do is within your risk profile, is very important.
Petroff: Okay. Now moving on to the idea of investing too much in your pension at a young age, that can’t possibly happen all that often, does it? And how is that a problem?
Morrison: I think a lot of people at a young age are keen to save but they also have unexpected financial circumstances that they might need to meet. Perhaps getting on the housing ladder, perhaps buying a new car. Having put money into a pension, they are not going to be able to take it out. At least using an ISA, perhaps they could take it out.
Petroff: Okay. So locking in your money into a pension too soon when you are young, might not be the best idea.
Morrison: Make sure you’re comfortable with how much you can get back out. Don't spoil your life for the sake of saving for something in 30 years' time. Enjoy yourself but get into the savings habit.
Petroff: Okay. And the last one is understanding pension rules. There are always lots of rules and they are always changing. So how do you go about understanding pension rules? You are the expert!
Morrison: It's a difficult one. I think I’ve had to sort of go back and revise my understanding of the pension rules. They change almost every year and the key is to keep on top of it. These days with modern technology, the internet will inform you, the press will inform you. If you’ve got a financial advisor, talk to your financial advisor about it. But the rules do change. ISAs are much simpler. And a lot of people don't understand the rules for taking money out as well as putting money in.
Petroff: So what's the worst thing that you could do with your pension? What's the biggest pension trap?
Morrison: I think the biggest pension trap is having a pension but not understanding it. Going into investment funds, not reviewing them, not making sure that your investment meets your change in circumstances, making sure that if you’re able to increase your contribution you can.
Understand it, look at it, review it and fit it into your overall retirement plan for the future.
Perhaps come up with an income that you’d be happy to live on from retirement and work backwards as to what your pension fund and your other assets will need to be to provide that income. Don't let it just sit there and wither on the vine perhaps.
Petroff: Okay. So maybe a once-a-year kind of check-up.
Morrison: Very much. In volatile markets, perhaps more frequently. Make sure you’re on top of it.
Petroff: Okay. Mike, thank you very much.
Morrison: Thank you.
Petroff: That was Mike Morrison from AJ Bell and I'm Alanna Petroff. Thanks for joining us on morningstar.co.uk.
