157- Pension Misconceptions

In this, the first episode in a 'misconceptions' mini-series, Benjamin talks all things pensions. Benjamin shares the most frequent misconceptions we tend to have when it comes to our pensions and why these may be damaging to our longer term financial health. 

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Transcript

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Hello money nerds and welcome to Heads Up on Money. It is I, Benjamin Mitchell. Thank you as always for joining me on Personal Finance Friday or whenever you are listening to this. This is episode 157 of Heads Up on Money. Can't believe it. We are racing towards the 200th episode. Will we get there? It's been a exciting time at the moment in my world. Busy, busy time with business. I don't know why at the moment there seems to be lots of lots of action amongst people, amongst their personal finances. A lot of new clients I'm speaking with at the moment seem to be coming to seek advice on on back of the changes that are likely to come into effect next April regarding their pensions and inheritance tax. So if you haven't already, Money Nerds, I would encourage you to listen back to that episode around how your inheritance tax position may be changing in April 2027 when your pension is included. Again, there's a full episode I've covered on that one. If you do want a deeper dive, check back previous episodes of the podcast. So getting into today's episode, what I'm going to do for today and potentially two or three more episodes thereafter, depending on what I want to talk about, is addressing misconceptions when it comes to your wealth and your money. Because a lot of the time we have these misconceptions, and I speak to new clients and existing clients, and I tell them something, and they think, oh, I I didn't actually know that. Or that's not how not's not how I thought that worked in practice. And it's often because of something we've heard down the pub or Chinese whispers, and the knowledge we have is confusing and perhaps damaging, most importantly, to your financial plan, because it may be preventing you from taking action on the back of it because of false knowledge. So today I'm going to start off the mini-series on misconceptions, and today we're talking about obviously my favourite subject, pensions. So today, episode one of this mini-series, I'm going to cover pension misconceptions that could potentially be costing you, money nerds, thousands of pounds. And I'm hoping by the end of the episode, it will hopefully have allayed some of your concerns regarding pensions or some of the preconceptions you have around pensions, and it'll give you some education and hopefully encourage you to take action where you may have not been doing so previously. So before I get into it, as always, it's a very quick call-out just to say if you are enjoying Heads Up on Money, whether you've been with me for the last three years, or if you're just tuning in to today's episode and are getting any kind of value from my Dulcet Tones, please do like and subscribe. Leave me a comment if you're listening on Apple Music, because it really does improve the podcast rating, and it gives me a nice shot in the arm confidence boost to know that these topics are actually landing well with you money nerds. So let's get into this without further ado. Misconceptions when it comes to your money. Today I'm starting with pensions. Now, as I've alluded to many times in the podcast, pensions they can be one of the most valuable financial assets you'll ever own. But they're surrounded with lots of myths, misunderstandings, lots of negative sentiment towards pensions. Some people think they're too risky, some people think they're going to be tampered with, some people think they're just too complex, and some people think they are something they should be worrying about in the future. But the reality is you need to take stock of this now. You need to become invested emotionally in your pension now. Now, of course, money nerds, you are the anomaly, you are the people who are actively improving their financial health by listening to Heads Up on Money every week. So I recognize you're going to be way, way, way ahead of the curve. But let's face it, for most people, pensions are just one of those things they just don't think about, often until it's too late. So when I'm thinking about what I'm going to talk about in today's episode, I've tried to think about the misconceptions that the conversations I've had with clients over the years that has stirred up new knowledge or readdressed any any false knowledge a client may have had historically. So I'm going to cover off the most common pension misconceptions I hear, and I'm going to explain exactly what is true. Now, as always, a little disclaimer for me is the podcast, as you know, is for general guidance, general information. It shouldn't be considered bespoke financial advice. So if you have a financial advisor, bring some of these topics to them, discuss with them how that may impact your financial plan or seek financial advice independently if you're unsure about how to enact any of this yourself. So let's get started. Misconception one, pensions aren't worth it because you can't access the money. Probably the biggest objection I see from people is they they have some apathy to the fact that a pension is going to be locked away for the longer term. Now that is the reality. That is one of the biggest rules around pensions, is you park money in a pension today, you're not necessarily going to be able to access that money tomorrow. Of course, you will be if you're of a relevant pension age. Crucial point on pension age is education point number one is a lot of people assume that your private pension age will be the same as when your state pension age is, which is not the case. Typically speaking, again, it does vary depending upon your ages, and some pensions may have what's called a protected pension age, but general rule of thumb is you can access your private pensions a decade before you can access your state pension. But private pensions in the traditional sense are locked up for the long term. So why on earth would I put money in a pension when I can't touch it for decades? That's what people say to me. And at first glance, that is completely understandable because nobody likes the idea of losing flexibility. But money nerds, here is the important point. This restriction, this lockdown, is actually one of the reasons why pensions are such an effective long-term planning vehicle. Pensions were designed specifically for retirement. The government provides you tax relief in the way in to pay into the pension to incentivize you to save for your retirement. And they're not doing that out of the goodness of their heart, they're doing that so you reduce your dependency on the state, so that you can afford a more luxurious standard of retirement than the government can afford to pay you. Now we'll come on to that later on around state pensions and whether workplace pensions and all the basics are enough. We'll come onto that later, but the fact that your pension is locked up and the fact that you get tax relief to pay into it means pensions are incredibly valuable. Now I'm not going to go into the mini shy of how pension tax relief operates in this episode. I've done it to death in other episodes of Heads Up on Money. But in essence, depending upon what level of taxpayer you are, means how much tax relief you'll be entitled to. So everybody will get basic rate relief, and if you're a higher or an additional rate taxpayer, you'll be due a chunk more depending upon whether you are potentially in a relief at source pension scheme or a net pay arrangement. I'm not going to go into that in the details of today. Different schemes operate in different ways, but basically, depending upon how much tax you pay will determine the level of tax relief you get on a pension. So when you pay into a pension, so too do the government. And that makes it incredibly valuable. Because you're not just putting £100 away into a pension each month for argument's sake. You're getting help from the tax system, you're getting free money from the government, which then goes into your pension fund. And that's before it's even invested in the great companies of the world and stocks and all of the great investing that you should be doing as long-term investors and money nerds. Before you even invest money in the market, you're getting an uplift on your capital because the government are giving you that stepping stone. They're giving you that extra rung on the ladder. Now that doesn't mean that pensions are suitable for every financial goal, because if you're saving for a house deposit, you're building up an emergency fund, you've got some short-term financial objectives, then of course the fact that pensions are locked up for the longer term is unlikely to be suitable for you. Pensions are probably not the right vehicle. But for retirement savings, which may be multi-decades away, they are incredibly valuable because this extra money you get paying into your pension in the form of tax relief will just mean that the compounding effect will be even more favorable, will be even more fruitful, so that when you get to retirement, you'll be amazed how much your pension will have grown. And if you've got multi-decades of retirement or building up pension growth ahead of retirement, I should say, then the argument is that you should strongly be considering giving your pension as much exposure to equities as you can, because the volatility that we know and love in stock markets, which is par for the course when it comes to investing, should be of no consequence to you because of the fact that your pension is locked up for the future. So that's what I'm getting at when I said at the start that the lock-up period for a long term is not a bad thing, it's actually a good thing because your inability to access the funds immediately to remove the temptation and to encourage you to push your growth potential up and accept some shorter term volatility, but it's par for the course, that is a great thing. It's a feature of a pension, not a flaw. Misconception number two: I will lose my pension if I die before retirement. What will happen to it if I don't make it to retirement? It's a misconception which remains surprisingly common. Many people worry if you pass away before taking your pension, that money vanishes, it disappears. In reality, modern pensions are often significantly more flexible than people realize. Most defined contribution pensions can usually be passed on to your loved ones, to your spouse, to your children, to your grandchildren. They offer masses of flexibility and not just tax efficiency in your lifetime, but for many people, pensions are a way of cascading wealth down the generations and the funds remain within a pension wrapper. So if you pass away with a pension pot and that goes to your children, it remains in a pension pot and therefore protected from things like income tax, capital gains tax for your children in the same way that it was for you. So pensions often retain the masses of privileges they have in your name when they pass on to your loved ones. Now, as I alluded to at the start, I'm busy at the moment because people are getting concerned with pensions and inheritance tax and all changes there. Again, not going into it in this episode, but at the time of recording, pensions are also efficient for inheritance tax reasons, because if you pass away at the time of recording, your pension passes on to the next generation without that pension falling into the net of inheritance tax, but that is changing next year. So pensions are not going to be as efficient from an inheritance tax stance, but other tax efficiencies, income tax, capital gains tax, largely, again, it depends on your situation, but largely will remain. So if you die before you reach retirement, let's hope you're not going to, your pension doesn't vanish, the money doesn't suddenly get paid out into your bank account and as at the moment subject to inheritance tax, but instead you have flexibility on what happens to that wealth. That is a pot of money, just like your bank account, just like your ISA. So pensions, if you've got reservations around paying into a pension, because who knows if I'm gonna be here in retirement, that money doesn't vanish. It can still be passed on to your loved ones, often with good financial planning in a very tax-efficient way. Okay, so misconception number three, I alluded to it briefly there, is that the state pension is gonna be enough. Massive, massive misconception. They think because you've been paying your national insurance over your career, that you're not going to need a private pension. The state pension offers you guaranteed income for the rest of your life. Happy days. But the state pension is not significant. Even if you have the requisite 35 years of national insurance contributions to qualify for the current basic state pension, broadly speaking, let's say 12.5 grand a year is what the state pension will provide you because there's a bit of noise at the moment regarding the fact that if the personal allowance remains frozen, then the state pension is going to increase above the personal allowance for the first time ever. Again, political side note, out with the scope of today's episode. But let's say 12.5 grand for ease, is that going to be enough to afford you the standard of retirement you would aspire to? The amount alone is unlikely to be enough, but also the access age is probably going to be far deeper into retirement than you would deem palatable. At the moment, you may be retiring at 67 with a state pension. Would you not rather have some kind of private wealth, private savings, private investments, private pensions that permitted you the flexibility to retire ahead of then? And that's the key point for people who are apathetic to pensions because they think they've got enough in the state pension or your pension is your state pension, I don't need a private pension. People who have that misconception could be damaging their financial plans. They could have to work longer than required because they don't have sufficient capital to meet the gap. Now I actually did an episode in the podcast on this very subject last, sorry, not last week, but two weeks ago, on the retirement danger zone, planning before your state pension kicks in. And that is one of the most efficient things you can do with your financial plans is try and articulate what you might want to look the earlier years of retirement to look like so that you're not a slave to the state, so that you do not have to keep working until your state pension kicks in, but rather you've got private wealth there, perhaps a private pension there to effectively meet the gap. So, big misconception is to assume that just because you're on track for the full state pension, you're going to be okay. The reality is if you're accustomed to a decent salary at the moment, you're going to have to take a sizeable pay cut if you're planning relying solely on your state pension. Misconception four, which is broadly linked, is I've got a workplace pension. My employer has got a pension for me, that's going to be enough. Now there's been direction of travel and progress here over the years with regards to auto-enrollment. Government plan whereby we were effectively saying people were not taking enough ownership of their financial futures, people were not paying into their pension, so instead, when you join an employer, you're automatically opted in, you have to make a concerted effort to opt out with the aim that more people become invested in their pension funding. But even those that are paying the auto-enrollment levels, if you're sitting here today having just subscribed the minimum amount into your pension, or if you're not even sure what you're doing and you've just gone with the flow when you joined an employer, then it's highly probable you'll be paying in the minimum amounts, as will your employer. You should actively consider increasing this because it's highly unlikely if you're just getting by on the bare minimum, that is going to be enough. Investigate with your employer. Can you increase your contributions with an incentive from your employer to increase theirs? Or is there a salary sacrifice scheme at work whereby you can sacrifice some of your salary with a view to you paying less income tax and less national insurance? And instead, your employer will pay all of your pension contributions for you from their pocket, which is a good thing for them also because they save employers national insurance. So salary sacrifice is one of many ways in which you can go above and beyond the basic minimum when it comes to your workplace pension. Also, I've cautioned many times in the podcast regarding your workplace pension, it's highly probable you're going to be in the basic fund that your employer enrolled you into. Investigate this. Is it suitable from a growth perspective? Are you invested in an appropriate amount of equities given your long-term goals or your age? Many people are sleepwalking into a retirement crisis because they're in a pretty crap fund that's offering low long-term growth. They're paying in the basic amount via auto-enrollment, and they think that's going to be enough. And then they get their annual pension savings statement from their workplace pension, and it's showing you this highly disgusting figure, which makes retirement seem like it's never going to be reached. And that I think is also what disincentives people from getting on top of their personal finances, from being invested in their pension. You get this annual statement, and it tells you how much your pension pot could be worth in the future, what that might mean if you buy an annuity. It's lower than you probably would hope, lower than you would expect. So as a result, you think, oh, what is the point? I'm just not gonna bother. I've said it before in heads up on money, and I'll say it many times again. You money nerds need to take ownership of your financial future. The government are not going to do this for you. Your employer is not going to do this for you. You have to address these matters yourself. Or of course, if you're working with an advisor. So, misconception number five, pensions, they're just a bit too risky for me. So that's a misunderstanding for many people, and I've said to it before, pensions, ISAs, people say my pension's crap, my ISA's crap, I'm getting nothing in the way of my pension, I'm getting nothing in the way of my ISA. Well, the reality is these are just wrappers, boxes that surround investments, and it's the actual flavor of those investments that will determine the long-term growth potential. As you nudge it up to equities, you can expect greater long-term growth potential with being accepting of greater short-term volatility. For many people, they think that's too risky, gambling, stock markets are not my thing, and they extend that to the whole pensions because they think that is what a pension is. Pensions are too risky, and as a result, the same pattern evolves, you become disillusioned and disengaged, and before you know it, you're sleepwalking into a terrible retirement prospect. So the real question, therefore, isn't are pensions risky? The question is how is my pension invested? And is that risk return profile that my pension is typically going to exhibit, is that suitable for me based upon my goals, my objectives, my feelings around risk? Again, this is where your financial plan is unique, but generally speaking, the view that your pension is risky is total misconception. It doesn't make sense. And wrapping things up to try and keep this fairly, fairly brief. Misconception number six, I'll just start later. I'll start when I've got a bit more money later on in life. When I don't have to contend with mortgage debt, when I don't have to contend with sending my kids to private school, paying for other, let's say, typical expenses whilst you're in the younger working years of your life, you think I'm going to sort it later. Well, that's perhaps the most dangerous misconception of all. Even if you are really pressed each month, and even if you can only afford to join your pension scheme at the auto-enrollment level, you should do it. Because when you are younger, the compounding effect and how much you're contributing matters so much more. You cannot make up the gaps later on, regardless of how much you throw at your pension later on in life, regardless of how much growth potential you give to your portfolio within your pension wrapper. The reality is starting earlier is better, and waiting until later is just a false economy. And many people think it's because you never know if you're going to reach tomorrow, but you can't base it on that. You have to do a little to both camps. And this is what I say to all my clients: good financial planning, it's about finding that balance. You can't afford to ignore your pension, but equally, you can't afford to aggressively fund your pension at the cost of enjoying life today. That's no fun. That is not the way you should be running your financial plan. But the idea that you can just do this later, do it when you're closer to retirement, do it when you actually care more about this, when retirement seems more tangible, more touchable, within grasp. It's already too late at that point. So the earlier someone begins saving and investing, the better. But it doesn't mean it's never too late, far from it. I've met people in their 50s who have made significant progress towards their retirement goals. But honestly, do yourself a favor, do future you a massive favor, start earlier, and it means that you'll have to do far less heavy lifting later on in life. Starting earlier often means needing to contribute less to achieve the very same objective. I'll let that one sink in and say it once more. Starting earlier often means needing to contribute less to achieve the exact same objective. Time on your side is the greatest asset in your financial plan. Okay, I'm gonna wrap it up there. Episode number one of our misconception series, we talked about some of the common misconceptions I see people say to me regarding their pensions. How many are you guilty of, money nerds? Again, these misconceptions could be damaging your financial plan because you're acting based on falsity and misinformation. Hopefully, in today's episode, I have managed to change the way you're thinking about some of this stuff. If you found that helpful, please do let me know. And if there's anybody in your life you feel may benefit from some of these nuggets, please do share the podcast with them. I will wrap it up there because I'm conscious I'm well over 20 minutes now, and never like to keep them much longer than that because we've all got life to lead, and personal finances is not the most sexy subject. But nevertheless, I'll be back next week, next personal finance Friday, for the next episode of our misconception series. But I'll wrap it up there. I hope you all have a fantastic weekend if you are listening to this on Friday. Otherwise, hope you've had a good week, and I will see you next Friday. Stay safe out there, money nerds. Goodbye again.