When times are tight, you may be keen to look for ways to cut back. But you need to think very carefully before stopping pension contributions or stripping cash out of your pot, as the implications can be really serious. Breaking off from pension saving is just one example of an action that saves you money initially but which will, over a longer time, end up costing you more – otherwise known as a false economy.
Other examples include dragging your heels on getting a will drawn up due to the upfront cost, or refusing to pay for tax advice even though this could mean you end up handing over significant sums to the taxman in the long run.
The false economy of stopping pension saving
Last month, worrying figures from HMRC showed the total value of taxable payments withdrawn flexibly from pensions since April 2015 when the ‘pension freedoms’ were introduced is a huge £72.2bn.
While this may help plug your finances in the short term, this could be very much a false economy unless you have a back-up plan to be able to generate a wage in retirement.
The worry is that people may be ceasing contributions or taking money out of their pension to tide them through the cost-of-living crisis, without thinking about the long-term consequences. Becky O’Connor from PensionBee, said: “Tread very carefully as you risk not leaving enough in your pensions to get through your whole retirement.”
As pensions are such a tax-efficient way to save for your later years, it makes sense to prioritise pension saving, even when finances are under strain. Even though stopping contributions may mean you make a cost saving each month, this is likely to be relatively small. By contrast, the impact on your retirement savings in later life will be dramatic due to lost tax relief.
Even if you plan to increase your savings down the line to make up for this, you’ve already made life harder for yourself. Stephen Lowe, retirement specialist at Just Group, said: “By triggering the money purchase annual allowance (MPAA), you significantly limit the tax relief future pension savings will attract, making that saving much harder work.”
Before deciding to reduce or cease contributions, make sure you’ve been through all your outgoings to see if you can find other ways to save money. If you do stop for a time, be ready to re-start as soon as you possibly can.
The false economy of not getting a will in place
Many people wrongly take the view that drawing up a will is not worth the cost – or the effort – as their loved ones will automatically inherit when they die. But this is not the case. Without a will, the ‘rules of intestacy’ will decide how your wealth should be distributed, and this may not be according to your wishes.
The cost of getting this vital document drawn up could be just a few hundred pounds. There’s even an option to do this for a ‘recommended donation’ of just £100 if you take advantage of Will Aid, a charity-based scheme, which runs through November.
If, on the other hand, you refuse to stump up this cost while you’re alive, there’s a risk that once you’re gone, the distribution of your estate could become problematic and the transfer of wealth could be disrupted. This could cost you – and your loved ones – a whole lot more in the long run. Shona Lowe, financial planning expert at abrdn, said: “A will is a vital document which sets out how you would like to pass on your wealth when you die. It’s vital to have one in place, and to keep it up to date.”
The false economy of not getting tax advice
When finances are stretched, you may well question whether it’s worth forking out for tax advice.
For those facing a hefty inheritance bill, the answer is almost certainly yes. While this used to be a tax on the wealthy, this is no longer the status quo, with the latest IHT receipts revealing that from April to August, the revenue raised rose to a huge £3.2bn. This was a significant jump of £0.3bn compared to the same period last year.
This should serve as a stark reminder of the importance of not scrimping on good tax advice, as it could save you huge sums in the long run. Ms Lowe said: “IHT is no longer the ‘wealth tax’ it once was. This means the total paid is increasing year-on-year, and with more people caught in the net, it’s more important than ever that people do what they can to reduce their IHT bill.”
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