Why pension pots built over the years risk being wasted: Sarah Coles

Before 2012, if you wanted to join the pension at work, you had to opt in. The problem was that most people didn’t: in 2012, only 47% of employees were members of their workplace scheme. Automatic enrolment ensured that if people did nothing, then as long as they made at least £10,000 from one job and they were aged between 22 and state pension age, they were automatically put into the pension scheme at work. By 2024, 82% of all employees were enrolled.

It’s not a perfect system. The Pensions Commission report this month highlighted that people still aren’t saving enough. The rules mean that in total, payments into your pension have to be 8% of ‘qualifying earnings’. Employers have to put in at least 3% - with the rest made up by the employee. This isn’t enough to cover everyone’s needs in retirement, especially if they haven’t paid into a pension for all their working life.

When these rules were set, the idea was that the state pension would replace around 30% of average earnings, these auto-enrolment minimums would replace around 15%, and anyone who could afford it would then make extra contributions on top to replace another 15%. In reality, the average worker pays in just 2% of their salary on top of these minimums, and the less people earn, the less likely they are to do so.

Private workplace schemes are increasingly likely to be what’s known as defined contribution pensions, which focus on building a pot, rather than defined benefit ones, which build the right to a certain percentage of your income in retirement. Within defined contribution schemes, people have choices over how that pot is invested.

Unfortunately, capitalising on inertia also means people don’t engage with their pension investments. Most never make a decision on investment, so automatically end up in the default fund. Some 79% have never looked at where their pension is invested. It means they’ve never considered whether the default fund works for them, or if they’re prepared to take more risk in return for more potential investment growth.

The rise of defined contribution schemes also means people need to make decisions around how they turn their pot into an income in retirement. It means that at the age of 55, they’re expected to transform from someone who hasn’t give their pension a second thought to a pensions guru.

People didn’t need the same level of knowledge when auto-enrolment was first introduced, because most people had to buy an annuity, turning a pension pot into an income for life. However, rule changes in 2015 meant more freedom, so there’s much more to get to grips with now.

There are some signs that not everyone is making the best possible decisions. The most common way to take money out of a defined contribution pension is simply to take it all out at once – 48% of pensions are emptied the first time any money is taken from them.

In many cases, this may be reasonable, as almost two thirds of the pots emptied were originally worth less than £10,000. When pots are this small, taking the money may have little effect on retirement income. However, savers could instead combine these pots with others. Otherwise, there is a real risk that people cash in several small pots because they view them differently from one larger pot and fail to consider the effect on their overall retirement income.

Taking all your tax-free cash has become the default position too – 83% of people who have accessed a pension for the first time since 2015 took the full 25%. And while this may be the right thing for some people, it has an impact on overall income. The Pensions Commission report showed that 43% of people are under-saving for retirement, but that rises five percentage points – to include an extra 2 million people – if you assume they spend their 25% tax free lump sum.

Just over a third of pension pots are put into income drawdown, which means some of the pension can be taken out to provide an income and the rest can remain invested. This offers real flexibility and control over your retirement income so managed well, drawdown has huge benefits. However, managed poorly, it brings new risks.

FCA research shows that 53% of people are cautious about their spending in case their pension pot runs out, so they may be living needlessly frugally. Meanwhile, others may be taking too much. The report warned around a third of pension pots worth between £100,000 and £249,000 are withdrawn at a rate of at least 8%. It ran an example of a pot of £165,000, minus a 25% lump sum, accessed at age 68 and withdrawn at a rate of 8% a year. It said the pot could be emptied within a decade – when a woman of 78 has over a 50% chance of living at least another 10 years.

There is some hope on the horizon though, because the introduction of targeted support will make a big difference. It will mean pension companies can offer helpful guidance to people drawing from their pension, to encourage them to consider their needs in full and make the right choices.

Over time, we’re also set to get a guided retirement regime for workplace pensions. It will mean that by 2028 there will be a default option for withdrawing, which will include a regular income. There is a vast amount still to be decided about this regime, but if the details are right, it could help those people who are really struggling to make a decision.

For everyone else, it’s vital to appreciate that the right retirement income isn’t just about the size of the pot: it’s also about how you take money from it. Instead of trying to become an overnight expert at retirement, the best approach is to build this knowledge slowly, reading up on pensions, seeing what support is available through your employer and getting advice if you need it. The only problem then becomes how to overcome the inertia that’s stopping you from getting round to it.

Energy price cap

Energy bills are set to rise 13% in July. It’s not a big surprise. It has been on the cards since the Iran war began, and wholesale prices climbed. The price cap has protected us from bill rises since the outbreak of war, but that protection is going to come to a horribly sudden end in July.

Households on fixed tariffs will still be protected from price hikes until their current deal comes to an end. If you’re currently on a price capped tariff, you could fix now and save money. There are also discounted tariffs worth considering. These are variable and will therefore rise when the price cap does, but they’re cheaper than the price cap, so will still save you money.