Contracting out, high fees, National Insurance gaps and other reasons your pension might be worth less than you think

Finding out that your pension is worth less than you’d hoped is a scenario many Brits dread. Here’s how it could happen to you.

Imagine spending decades working hard and diligently paying into a pension, only to reach retirement age and find yourself facing hardship in old age.

Sadly, however, many of us could be in for a nasty surprise, with research from The People’s Pension and YouGov earlier this year revealing that 19% of savers have never checked how much is in their pension pot.

In this article, we look at some common reasons there could be a shortfall in your retirement income. 

1. Contracting out of the State Pension

Many people face a shock in retirement if they’ve been ‘contracted out’ of the State Pension without fully appreciating the implications.

Prior to 2016, you or your pension provider could decide to ‘contract out’ of the Second State Pension – this was an element of the State Pension based­ on work-related earnings.

If you were contracted out, you either paid lower National Insurance contributions or a portion of your contributions was paid into another pension – for example, a workplace pension.

In exchange, those who contracted out forfeited some – or all – of their Additional State Pension.

Although this practice ended in April 2016, any time at which you were contracted out will still impact the amount of pension you receive.

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2. Gaps in your National Insurance record

If you have had any periods in which you had low earnings, were unemployed or not claiming benefits, you may have gaps in your National Insurance record.

For anyone reaching State Pension age after April 2016, you’ll need at least 10 years of contributions to receive any State Pension and 35 years to receive the full amount.

You’ll only need 30 years of contributions if you reached State Pension age before 2016.

If you’re concerned about any gaps in your National Insurance record, you can make voluntary contributions, which­­ could top up the amount of your State Pension.

You can typically only fill gaps in your record that relate to the past six years.

At the time of writing, however, there is an exception to this rule. When the New State Pension came into force in 2016, the Government introduced special rules to allow people to plug any gaps back to 2006.

However, you’ll need to do so before April 2025.

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3. Political volatility is hitting markets

If you don’t have any interest in politics, it may be difficult to imagine that international tensions could affect your bank balance.

However, major world events such as war or political turmoil often make financial markets jittery, which can cause the value of pension funds to plummet.

Think Liz Truss and the notorious mini-Budget. Experts calculate that its disastrous policies helped wipe £425 billion off pension fund assets in 2022.

Although this might be an extreme example, there are plenty of times in which political or economic turmoil can cause pension values to fall.

Fortunately, these drops are unusually temporary, and markets will eventually ride out any periods of short-term volatility.

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4. You invested in a ‘lifestyling’ fund

Under this strategy, your fund manager automatically moves your savings into lower-risk funds as you near retirement age – the theory being that you should be more conservative with your investments if you have limited time left in the markets.

While there is logic to this approach, it isn’t for everyone.

As these funds automatically move you to a lower-risk model, you may suddenly be left with a set of investments that don’t reflect your personal circumstances or risk tolerance.

If, for example, you decide to work beyond your retirement age, it may be more appropriate to hold your assets in a higher-risk investment for longer than it would for someone who retired at 50.

5. High management fees

Deciding whether to pay for advice is one of the biggest considerations when investing in a personal pension.

Paying for this service should theoretically grant you access to your adviser’s expertise in the field of investments. However, these charges can significantly erode the value of your fund over time.

Although advisers’ fees vary, Unbiased has found that these charges are typically between 1 and 2% of a fund’s value – although fees may be lower for larger funds.

If you decide to pay for pension advice, it’s essential that you factor these charges into any forecast for your retirement income.

You should also ensure that you understand what this fee includes and the level of advice you’ll receive for your money.

6. Taking your eye off the ball

Unless you regularly check your fund’s value, you’ll have no way of knowing how your pension is performing.

While temporary fluctuations are inevitable on even the best-performing funds, you should watch out for longer-term trends in your pension’s performance.

In short, you shouldn’t be overly concerned with performance on a day-to-day basis, but you should compare performance on a month-by-month or year-by-year basis.

And if you’re paying a financial adviser, don’t be afraid to ask questions if you have any concerns about your losses or gains.

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