RETIREMENT GUIDE: pension mistakes to avoid – part 2

You’ve spent a working lifetime saving for your retirement goals, contributing to pensions and perhaps investing additional assets in an individual investment plan. Now, you’re finally on the verge of retiring. However, you may be surprised to find that retirement planning doesn’t stop once you retire.

To keep all of your life and retirement goals on track, there are several pitfalls to avoid, as you embark on this new, exciting chapter in your life.

In my second blog on this topic, I highlight some of the mistakes to avoid. The risks highlighted below are not exhaustive and many of us will have our own individual risk factors to navigate.

Placing ‘big bets’

Few people would actively go into a casino and gamble with retirement savings. As rational beings generally understand the high risk nature of such an action.

And yet there is a fairly common ‘big bet’ that isn’t viewed that way by most people. That bet is holding a large portion of your retirement savings in your employer’s shares. You might feel positive about the company and its prospects, as well as a sense of loyalty to the employer.

Maintaining a large part of your overall net worth in an employer’s shares is making an investment decision based on emotion, which may not be what is best for you and your retirement.

A more dangerous ‘big bet’ mistake is staking a large portion of your retirement savings based on a hot tip, new trend or an initial public offering you think is going to ‘take off.’

Taking on a ‘big bet’ can be tempting, especially if you feel the need to catch up on your retirement savings or if the person giving you the tip is someone you respect. Yet that is mixing emotion and investing decisions, a potential recipe for regret.

Misunderstanding risk / reward dynamics

Before 2015 most UK retirees with personal pensions would purchase an annuity as they entered retirement. It was common at that time for pensions to ‘de-risk’ on approach to the individual’s retirement date, in the anticipation of using pension funds to purchase an annuity.

Since the 2015 Pension Freedoms legislation Flexible Access Drawdown has become the favoured approach to generating income in retirement. Yet many retirees still believe they need to take a cautious, low-risk approach to retirement planning.

Some desire predictable income streams, the protection of principal and peace of mind.

However, if you need long-term portfolio growth to reach your financial goals, investing too cautiously or not at all could increase the risk you run out of money in retirement or fall short of other goals. Investing carries an inherent risk-return trade-off. To earn higher long-term returns, you will have to endure market volatility and accept more risk; however, whether this is appropriate for you depends on your personal situation, goals and other factors.

Paying excessive fees

A common mistake retirees make is paying excessive fees. In some cases, paying excessive fees can cost you many thousands of pounds over your lifetime.

The fees cost you in two ways: first, the actual out-of-pocket expenses and charges; second, the money you spend on fees is money that is not working for you. Over a lifetime of investing and because of the power of compounding, this can turn into a very large figure.

It’s always prudent to compare costs and charges to ensure your investments aren’t being hindered by excessive charges or hidden costs. The chart below illustrates the impact of a 1% difference in charges over 25 years, a typical retirement investment period.

Mismanaging pension withdrawals

When it becomes time to switch gears from saving to spending, many people have trouble making the transition. In fact, after working with hundreds of retirees in this situation, it is clear that deciding how to generate income and how much to spend can feel like complicated and confusing aspects of retirement life. Even if you have accumulated a large nest egg, making the wrong withdrawals could put your retirement at risk.

Generating retirement income requires you to balance a range of elements, many of them beyond your control, such as inflation, equity-market volatility, interest-rate trends and your and your spouse’s expected longevity. Be too conservative in your investments and you risk having inflation strip you of purchasing power.

Too aggressive and you risk losing your money. Take too much income early in your retirement and you risk running out of money in your later years. Too stingy with your withdrawals and you might be cheating yourself out of enjoyable experiences. It’s a tough proposition with lots of emotional components. And that’s often a recipe for disastrous decision-making.

For example, investors may assume, given the stock market’s average returns of about 10% a year, they can take 10% out a year for the rest of their lives.* But that is a recipe for disaster because the market doesn’t move in a straight line. For example, if the market turns bearish and drops 20% (such as now, in June 2022), and you still take 10% out, you will need a 39% gain just to get back to the initial value. A couple of years of that kind of bear market withdrawal and you could be in a bad situation right when you are running out of time to recover.

*figure used for illustrative purposes

Other people take a different tack: They take out too little because they are afraid to touch their principal. It is perfectly fine to reduce your principal, provided you have a large-enough retirement nest egg to last your entire life. The other reason to touch your principal is that your investment goals don’t require it. Perhaps you don’t want to leave money to any person or organisation. Or maybe you simply want to live it up a bit more.

Like so many things, the key is to know yourself and your goals and find a balance of what feels right whilst protecting your downside if things go poorly.

Whilst rules of thumb don’t take into account your unique situation, most people should plan on taking out no more than 5% a year. Strategically planning withdrawals can be complicated. That’s why we offer our clients advice and planning to manage withdrawals that are prudent, tax-efficient and can help lead to peace of mind.

Conclusion

How you plan your finances in retirement is just as important as your journey to save for retirement. It’s crucial to understand the available options to help protect the assets you’ve spent a lifetime accumulating.

My aim in sharing these ‘mistakes’ is to help you avoid them. Avoiding future regret is a large part of retirement financial planning.

“Mistakes are costly, and somebody must pay. The time to correct a mistake is before it is made. The causes of mistakes are, first, I didn’t know; second, I didn’t think; third, I didn’t care.”

Henry H Buckley

If you wish to understand better the potential retirement mistakes relating your own circumstances, please get in touch and we will be happy to assist.

Barra Gorman FPFS

Chartered Financial Planner