4 common and costly mistakes “DIY dippers” make with their pension pots

4 common and costly mistakes “DIY dippers” make with their pension pots

As we head towards spring you may be planning some DIY around the house or garden. If so, an article by Wellbeing News makes for sobering reading, as it reveals the number of people admitted to hospital with DIY injuries rose 11% between 2020 and 2022.

While DIY around the home may be bad for your health, DIY retirement could be bad for your wealth. Despite this, research by retirement specialists Just Group revealed that 53% of people with a defined contribution (DC) pension – otherwise known as a “money purchase scheme” – accessed their scheme for the first time in 2021/22 without financial advice.

If you’re considering accessing your pension without talking to a financial planner, you may want to reconsider. Read on to discover four common mistakes made by “DIY dippers” that could result in a hefty tax liability, the loss of your retirement fund or your pension running dry.

1. You could pay too much tax

Typically, you’re allowed to access up to 25% of your pension pot tax-free. Any income that you take from the remaining amount will usually be taxed at your marginal rate of Income Tax. This means that if you take a larger income than you really need, you may push yourself up into a higher tax bracket.

As a result, you could face a 40% higher-rate Income Tax liability instead of the basic rate of 20% (2022/23). Alternatively, you may increase your Income Tax rate from the higher rate of 40% to the additional rate of 45%.

Working with a financial planner can help you understand how much income you need to maintain your lifestyle, and the most tax-efficient way for you to draw it from your retirement fund.

Furthermore, if you intend to work while drawing an income from your DC scheme, a planner could help you avoid the Money Purchase Annual Allowance. Read more about this little-known regulation, which could reduce the future growth potential of your pension.

2. You may fall victim to a scam

As pension pots can be worth significant amounts of money, scammers are increasingly beginning to target them. According to research featured in MoneyWeek, one in four (28%) pension savers now say they are worried about falling victim to fraud.

The time you access your pension could be a key opportunity for criminals, who may try to use it to take your retirement fund. One common scam that criminals use is a “pension liberation scheme”, which scammers claim allows you to access your pension pot before you reach the minimal retirement age of 55 (2022/23).

Always be extremely sceptical if you’re offered this, as you can usually only access a pension pot before the minimum retirement age under very rare circumstances, such as having a terminal illness. If you do access your pension before reaching 55, you will typically face a significant tax liability and hefty charges, which could quickly deplete your retirement fund.

Speaking to a bona fide financial planner when you decide to access your pension pot could ensure that you avoid a scam, and a decision you later regret.

3. You could deplete your pension pot

According to the Office for National Statistics, if you’re a man you could expect to live until the age of 85, and if you’re a woman you could live to 89. This means your pension pot may have to last 30 years or more, depending on when you retire.

If you inadvertently take an income that’s too high, you could accidentally deplete your pension much earlier than anticipated. If you do, you may have to significantly reduce your retirement lifestyle.

This becomes more of a risk during periods of high inflation, as we saw happen in 2022, as you may have to withdraw higher amounts from your pension just to maintain your lifestyle. Despite this, MoneyAge reveals that just 37% of over-55s factor inflation into their retirement strategy.

Thanks to the use of sophisticated cashflow modelling software, a financial planner can ensure that you take the right level of income from your pension. Furthermore, they could provide options that may help you maintain your lifestyle without increasing the amount you draw from your retirement fund.

4. You could access your pension at the wrong time

As we head into 2023, the uncertainty around the global economy that we saw in 2022 looks as if it’s going to remain. As such, the stock market could remain volatile.

If you access your pension pot during a stock market downturn, it’s likely that you will need to sell more of your investment units to provide the level of income you want. As this could then reduce the amount of units left within your pension, your pension’s future growth potential could be significantly reduced.

As such, your pension pot may not be able to cover the level of income you’re drawing for the long-term, which means you could deplete your retirement fund earlier than expected. This means you may not be able to maintain your lifestyle.

A financial planner can help you budget more effectively so that you can reduce the amount of income you take from your pension, which in turn could reduce the impact of a volatile stock market. Furthermore, they could provide other options, such as living off other assets such as savings until the stock market bounces back.

Get in touch

If you are coming up to retirement and would like to discuss accessing your pension pot in a tax-efficient way that will not potentially deplete it, please call us on 0800 434 6337. We would be pleased to help.

Please note:

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.