Financial expert James Shack explained that many people seek guidance from him when planning their retirement to avoid simple mistakes, but there are a growing number of people who present problems that he “can not fix”.These are mistakes that cannot be undone and that can seriously jeopardize one’s future, he warned. Worryingly, this could potentially adversely affect their retirement and empty their pensions.
In a new YouTube video, he discussed the three biggest defined contribution pension mistakes made by some of his retired clients and explained how and why they should try to avoid them.
Redemption of an entire pension as a lump sum Mr Shack explained that a pensioner withdrew his entire £ 200,000 pension to invest it in a property to buy for rent.
The man received £ 50,000 tax-free while the rest was taxed as if he had earned the income in the only year.
As the man still worked and was a high taxpayer, he ended up paying £ 67,000 in income tax, meaning he had only £ 132,000 left.
In addition, as he was still employed, he and his employer still put £ 15,000 a year into a separate pension, but since he already had flexible access to his second pension, there is now a limit to how much he can invest in his pensions. £ 4,000. This means that £ 11,000 of his money is taxed.
Shack said: “Not only has he paid £ 67,000 in advance pension tax, but he also has to pay £ 4,500 in tax each year as he continues to work as he otherwise would not have had to pay.
“There’s no way you can come back from this.”
Use tax-free lump sums to pay off mortgages
Another mistake that Shack has witnessed is that retirees want to pay off their mortgages with their tax-free lump sum from retirement.
DO NOT MISS
The next example he gave was a couple who had £ 250 a month payment on a 1.25 per cent interest rate loan that they did not want to hang over them when they retired. They ended up taking £ 200,000 tax-free money from their pensions to pay off.
He said: “We have £ 200,000 coming out of a tax-free growth environment, so if invested properly it could potentially see an average of say six per cent return and turn into £ 250,000 over the years.
“At the same time, £ 200,000 mortgages have an interest rate that, as I say, is lower than the inflation rate, which means that with each passing year, that debt becomes smaller and smaller in real terms.
“So, you take £ 200,000 out of a unique, tax-efficient investment opportunity to pay off a debt that, in real terms, gives you money.
So, another option could be to just keep the £ 200,000 invested and find a way to cover these mortgage payments or you can deduct just enough each year from your pension to cover the payments.
“This may not be the right solution for everyone, but interest rate loans can be a great tool for accessing money tied up in your home, especially when you are still planning to cut back in the future.”
Take tax-free money to top up ISA
Many people prefer ISA to pensions because they can be easier to understand. With a limit of £ 20,000 each year, it can be tempting to want to use tax-free pension funds to replenish this, but Shack explained “this is a bad idea.”
Pensions have the same tax benefits as an ISA, but pensions have an extra benefit that makes them “much more superior” than the ISA, he suggested.
He also explained the benefits of retirement inheritance. People who die before the age of 75 can tax-free transfer their pensions to a close relative.
People who die after the age of 75 can inherit the pension without inheritance tax as well, but they must take it out and pay income tax at their own marginal tax.
However, ISA is part of one’s property and people may have to pay inheritance tax on them.
Mr Shack added: “That’s why it may be preferable to sell your ISAs before your pensions when you create a pension income. Sometimes you actually do not want to touch pensions at all because they are such fantastic inheritance tax funds.”