Eight pension myths – debunked

The rules around pensions can seem complex and confusing, and the details are often changing. This can leave savers feeling bewildered when it comes to their long-term retirement plans.

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Here, we consider some of the myths – and what you need to know.

Myth 1: The state will provide enough for me

The new state pension pays £221.20 per week, which works out at around £11,500 per year. This is unlikely to provide for even a very modest standard of living for a single person.

Depending on your working history, you might find you do not qualify for the full amount. You can check your state pension entitlement at gov.uk/check-state-pension.

Myth 2: Annuities are dead

Since the introduction of pension freedoms in 2015, income drawdown has offered pension savers a more flexible approach to producing a retirement income. Meanwhile, annuities have become less popular.

But annuities can be a useful part of retirement planning, by providing a secure income to cover everyday bills, for example. Purchasing a guaranteed income for life in the form of an annuity could be invaluable for many people.

Myth 3: Tax-free cash is always 25% of your pension pot

The headline rate of pension tax-free cash is 25%, but this is capped at £268,275 for most people. Some pension savers with older style company pension schemes may find that they have a greater amount of protected cash available. Yet some people in these occupational schemes often forget that they are eligible for this. 

It is always worth enquiring about your pension’s benefits, rather than assuming they are the same as other schemes. A financial adviser can help to clarify your situation and ensure you don’t lose valuable benefits.

Myth 4: Pensions are the only way to fund retirement

Although pensions and retirement go hand in hand, your income in retirement can come from several different sources, including cash savings accounts, shares, ISAs, and property. 

ISAs can be a tax-efficient way of funding retirement because you don’t pay income tax on withdrawals. What’s more, ISAs form part of your estate when calculating inheritance tax (IHT), whereas pensions usually fall outside of your estate and so can be passed on to your beneficiaries free of IHT.

Myth 5: It won’t be beneficial to take my company pension before 65 because I will pay a penalty

Benefits taken before age 65 may be subject to a penalty, but it might be worth it. If you take benefits early from a defined benefit (or ‘final salary’) scheme, there could be a reduction in available income. You would be getting a lower pension, but for a longer period. This could, for example, potentially put you in a lower rate tax bracket.

However, you might want to consider what other savings you could access first, such as ISAs or other investments.

Myth 6: I am OK because my retirement savings are in a default lifestyle fund

This might be the case if you are planning to retire at your pension scheme’s normal retirement age and will purchase an annuity. But, if you are planning to retire in a more flexible way, by taking semi-retirement, say, or working longer, then looking at the details of the default lifestyle fund your pension is invested in is particularly important.

Lifestyle funds shift your money into less volatile assets such as cash and bonds the closer you get to retirement to avoid any sudden losses. However, this approach is unlikely to be appropriate if you are planning to use income drawdown for some or all of your pension income.

Myth 7: My pension dies with me

A defined benefit pension scheme might be limited to paying an income to your dependant. However, most other pensions enable you to leave your pot to a beneficiary, and they don’t have to be your partner. Make sure that your provider knows who you would like to leave your pension to by completing an expression of wish form. You can name as many beneficiaries as you like, but the pension scheme trustees usually have ultimate discretion as to who receives your fund.

If you die before age 75, pension benefits can usually be passed on tax free. Bear in mind that if you take your tax-free lump sum but do not use it before you die, it becomes part of your estate and your beneficiaries might pay inheritance tax on it. 

Myth 8: I am in a workplace pension and so don’t need to worry 

For most people, simply enrolling in your company pension scheme will not be enough for a comfortable retirement. It may even be possible that your pension pot will need to last for around 30 years in retirement. So, the contributions made to a basic workplace pension may well not be enough on their own. 

Seeking financial advice can clarify your retirement strategy, reduce tax liabilities, and ensure your plan is specifically tailored to your individual needs. 

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The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy.