Five ways to wreck your retirement

Worried about your retirement? Avoid these five pension perils!

Here are lovemoney.com, we like to be positive about pensions. Not that we often have very much to be positive about. But still, we try.

Having said that, we realise that, sometimes, all you really want to know is what not to do. In other words: the mistakes to avoid.

So, without further ado, here are five surefire ways to wreck your retirement:

1. Never reviewing your pension plan

According to new research by Baring Asset Management, almost 17 million working people in Britain (48%) have never ever reviewed their pension plans. So, for example, these people set up a pension in their twenties, faithfully contributed every month but ignored what was happening to their money for the next forty years or so.

Crazy, isn’t it? You can clearly see why there’s a good chance you’ll end up with a less than healthy pension pot given decades and decades of neglect.

It’s a rather worrying statistic that just one in five people (21%) have revisited their pension plans in the last year. To avoid a painful surprise when you come to retire, make a point of investigating how well your pension is performing at least once every 12 months.

Remember, if you can reduce the cost of your pension by 1% per year it'll probably make a significant difference after ten years and a huge difference after 30. We're potentially talking tens of thousands of pounds difference here. You can read about some very cheap options in Two simple ways to invest better in shares.

2. Choosing the default option

The Baring Asset Management survey also found that, among those have reviewed their pension plans, 38% - that’s almost 7 million pension savers - chose to invest all their pension contributions in the ‘default option’ fund.

This is the fund which your savings will be automatically directed into unless you take the time to choose your own investment funds. It is supposed to represent a sensible investment strategy for the average pension saver. But this can lead to decidedly average performance, if not worse.

Why? Because most default options fall into the ‘Balanced Managed’ sector. This means the fund will invest no more than 85% of its assets in equities (shares), a strategy that often tempers growth in the long-term.

Indeed, over the last five years, the average Balanced Managed fund has returned less than 21%. A more proactive approach should mean you can do better than that. Read How to successfully diversify your portfolio to find out how to choose a balanced range of pension funds better suited to long-term growth.

3. Cutting your pension contributions

In the current tough economic climate, pension contributions are often among the first ‘luxuries’ to be cut. This is a surefire way to leave yourself penniless in retirement.

Let’s imagine you’re 35 and you’ve been paying £200 a month into your pension plan. With basic rate tax relief, your total contribution is £250. If you continue to make £200 contributions, when you retire at 65, you could have built up a pot worth £11..

Now, let’s imagine you cut your pension payments by 5% to £190 a month. With 20% tax relief added, your total contribution this time is £238 – so just £12 less every month.

So, how might this seemingly small reduction affect your pension? After 30 years, your fund could be worth £105,000. That means you have lost a chunk worth £6,000. Sure you’ll have saved £3,600 by paying £10 less out of your own pocket each month, but you’re still £2,400 down.

What’s worse, knocking £6,000 off your pension value could reduce your income by £200 every year for the rest of your life. If you survive for 20 years in retirement, that could mean losing £4,000!

Read Boost your pension by £13,000 for tips on how to make sure you can afford to make contributions.

4. Forgetting about inflation

Even if you are carefully squirreling money in your pension every single month, don't forget the amount you invest today won't be worth anywhere near as much in twenty or thirty year's time. So, you'll need to increase your contributions in line with inflation.

As a rule of thumb, try to invest half your age as a percentage of your earnings – so if you’re 30, invest 15%, if you’re 40, invest 20% and so on. This should help to inflation-proof the value of your pension contributions over time, and give you the best possible chance of generating a healthy pension pot.

5. Relying on the State

If there’s one message this Government seems keen for everyone to take onboard right now, it’s this: don’t rely on the State to provide an income for you in retirement.

First, they pushed back the State Pension age four years early, so that from 2020 men and women will have to reach the age of 66 before they can receive it.

And then this week, the Government announced plans for a radical overhaul of the Basic State Pension itself, which currently includes means-tested elements. These would be scrapped in favour of a set amount of £140 a week, payable to everyone, as opposed to the current rate of £97.65 for most people.

The thinking behind it is that some low-earners are being put off saving for retirement because they will lose means-tested pension benefits if they do so.

It is being widely hailed as improvement to the pension system, especially for women who often do not have enough National Insurance contributions to qualify for the full Basic State Pension at the moment. However, there is a concern that the Government will not be able to afford to provide a living wage as a universal benefit to all pensioners, and therefore may allow inflation to erode the value of the sums they pay out.

The key thing to take onboard is that Governments can and do make changes to State pension payouts, and the only way that you can be sure you will have a decent income in retirement is to provide one for yourself.