Financial traps people fall into over the years

Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest

Spending not saving

Living within your means is a challenge for many twenty-somethings who are starting out in their careers, often with student debt and sky-high rents to contend with. So finding extra cash for savings can be tricky However, even small, regular savings can make a difference. A good habit is to save as soon as you’re paid, rather than waiting to see what’s left at the end of the month. Getting into the savings habit and building a nest egg can also help you avoid expensive debt: as you will have funds to call on in an emergency.

Tax-efficient ISAs and high-interest savings accounts are excellent starting points. Use cash ISAs for short-term goals, such as next year’s holiday or a new phone, and consider investment ISAs or Lifetime ISAs for more medium-term and longer savings goals, such as saving for a house deposit.

Not taking enough risk

This isn’t about off-piste skiing or bungee-jumping in South East Asia, but having a similarly adventurous outlook with your longer-term savings. Money in pensions and investment ISA holdings should be invested for the longer-term, so you can afford to consider higher-risk funds and portfolios. These may be more volatile in the short-term but have the potential to deliver higher returns over longer time frames. Historically, equities have outperformed cash over 10-year periods for example. Higher-risk equity funds might include those invested in emerging markets, and smaller start-up companies and technologies that have the potential to shape tomorrow’s world. However, always ensure your investments are diversified to avoid overexposure to any single share, sector, or region.

• Read more on 5 money mistakes people make in their 20s

Underestimating the cost of starting a family

Family planning should perhaps include the financial aspects of having children, as most people seriously underestimate the likely costs. A recent report suggests that couples will spend around £166,000 raising a child to the age of 18.¹ Of course, no one can realistically save this in advance, but it helps to have a plan for managing some of these costs to prevent financial stress later on. This includes covering any periods on maternity or paternity pay, where you may be on a reduced income.

Childcare costs have also risen faster than inflation in recent years, making the pre-school years particularly expensive, especially if one parent is working part-time or reduced hours. Make sure to claim any Child Benefit due and explore the government’s Tax-Free Childcare scheme to help mitigate some of these expenses.

Thinking retirement is years away

Strictly speaking, it’s true that it will be decades before people in their 30s reach the state pension age, but this is precisely why it’s the perfect time to start saving for retirement. Money saved in your 30s has longer to grow thanks to compounding, meaning a pound saved now will be worth more than a pound saved in your 50s, assuming similar growth rates.

You’ll benefit from returns on your returns over time, which can help grow your retirement pot in much the same way that a snowball rolling downhill grows larger. People in their 30s may not have lots of spare cash, but saving small amounts regularly can help build a more secure future.

This longer time horizon also means you can afford to take more risk with your money, investing in equities and other growth assets which historically have outperformed cash over longer time periods, helping your savings keep pace with inflation, although there is likely to be volatility in the interim.

• Read more on 5 money mistakes people make in their 30s

Too much focus on current spending needs

People’s salaries often increase in their 40s, but this is often matched with higher spending. Some of this is inevitable: growing families necessitate larger homes, bigger cars, and ever-growing food bills from ravenous teenagers! But many people will also want to start enjoying the good things in life during this decade — be it exotic holidays, home improvements, or more stylish clothes to suit that promotion.

However, it’s easy to fall into the trap of ‘lifestyle creep’, where additional income is simply used to upgrade your lifestyle, without considering future financial needs. Instead explore ISAs and other savings and investment options. These can also help ensure that living standards are maintained if your income dips — so you don’t have to fall back on credit or debt if there is any future income shortfall. There’s nothing wrong with living the good life, but make sure it’s both affordable and sustainable.

Failing to ensure pension contributions keep pace with pay rises

Many people in their 40s will be on far better pay than earlier decades. But make sure you use promotions and pay rises to boost pension contributions too.

Most workplace pensions take a fixed percentage of your salary as pension contributions, so a pay rise will mean more money going into your retirement savings in pounds and pence. But consider upping the contribution levels too.

For example, if you get a 3% pay rise commit to paying an additional 1% of your salary into your pension. Your take home pay will still increase (by 2%) but you’ll see a more significant boost to your retirement savings, particularly as this percentage will be based on a higher basic salary. This strategy is doubly effective if you’re in a scheme where your employer matches your contribution level.

If you’re self-employed and save into a Self-Invested Personal Pension (SIPP) (or other personal pension), make sure you boost contributions when you get a pay rise. Many people set up a £250 or £500 a month direct debit and are still paying the same amount years later, even though they may now be on significantly higher earnings.

• Read more on 5 money mistakes people make in their 40s 

Failing to maximise savings while you’re still earning

Many people reach their peak earnings during their 50s. At the same time, heavy demands on their income can start to decline — be it childcare costs or the end of mortgage repayments. The 50s, for many, feels like the decade when finances start to get on an even keel.

For those in this position, it makes sense to maximise savings during this period. Pensions are a good place to start. Employers are required to contribute to these, and many offer ‘matching’ schemes, where their contribution will increase if employees also pay more.

If this is available, make the most of these additional payments; you wouldn’t turn down a pay rise, so why miss out on contributions that can help boost your pension pot?

If you are self-employed, or this 'matching' option isn’t available, it can still be beneficial to maximise pension payments, through a workplace pension or SIPP, as contributions benefit from tax relief. For those that want to seriously build up their pension fund, salary sacrifice schemes can be a tax-efficient way to put more money into their pension.

Alternatively, you might also want to look at other savings options. Making the most of your tax-free ISA allowance should be your first port of call. People can save up to £20,000 a year into ISAs, which includes both cash and stocks and shares ISA options. Although there is no tax relief on contributions, money can be taken out tax-free at a later stage.

Being too cautious with your investments

Many 50-year-olds will be invested in older-style pension or investment plans that automatically start de-risking a decade out from retirement. These ‘lifestyling’ plans were often set up at a time when most people bought an annuity at the age of 65, so are designed to avoid a sudden drop in value prior to this, due to stock market fluctuations.

But times have changed. Most people now keep pension funds invested beyond retirement. In your 50s you are potentially looking at a further 20-year investment horizon, so may be less concerned about shorter-term market volatility. Playing it safe and shifting assets into cash, gilts or bonds is likely to restrict future growth potential, meaning the value of your investments may not keep pace with inflation. With this in mind, it is important to review pensions and investments to ensure the investment strategy remains appropriate and suits your risk tolerance.

This also applies to those cashing in part or all of their pensions, but opting to keep these funds in a savings account over the longer term. If inflation stays at a modest 2% — well below levels seen in recent years — in 10 years’ time a £20,000 pot will have the same buying power as £16,407 today. (This does not take any interest paid into account).

At 4% inflation, the same pot will effectively be worth just £13,511 in a decade.² There’s a reason inflation has been called a ‘slow motion bank robbery’. No one wants to take crazy risks with their money, but playing it too safe can also damage your longer-term financial prospects. 

• Read more on 5 money mistakes people make in their 50s

Not seeking help with retirement planning

There’s no doubt there are a raft of complex financial decisions to be made as people approach or move into retirement. Knowing what to do for the best isn’t always easy, as there is no simple ‘right’ or ‘wrong’ checklist — much depends on your own individual circumstances. With this in mind, it can help to talk things through, not just with family members but an informed money expert.

Some people choose to pay for financial advice, although this is likely to be more cost-effective for those with larger savings pots. But regardless of the size of your pension, everyone aged 50 or over is entitled to a free review session with the government’s Pension Wise service to talk through their options. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944. 

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

Most pension experts recommend booking such a session before taking pension benefits — be it your tax-free cash, or regular payments. Evidence suggests relatively few people are taking up this option though, with just a third of people accessing their pension in the past few years booking a Pension Wise appointment — despite the fact that nine out of 10 of those who’ve used this service say they felt more informed about their pension options as a result.

Splurging tax-free cash on holidays and home improvements

After a lifetime of work and sensible pension saving, the option to take a quarter of these funds as a tax-free lump sum can seem like a well-deserved bonus.

Many take this tax-free cash on retirement — though some will grab this lump sum even earlier, with pension freedom rules allowing access to pensions from the age of 55 (57 from 2028).

Pensions are designed to provide a retirement income once you stop working, but many people don’t think about this tax-free cash in the same light. Perhaps it is the ‘tax-free’ label that encourages people to spend, spend, spend. Research suggests only one in four pension savers intend to use their tax-free cash for retirement income, with home improvements, holidays, and buying a new car among the most common ways that people use this money. What’s more, this money is often spent quickly, with around a third of this tax-free cash gone within six months of people taking this benefit.

But you can only spend pension savings once, and depleting up to a quarter of your retirement fund right at the start of retirement can seriously impact your finances over the longer term. You don’t lose this tax-free benefit by keeping these funds invested until you need them. In fact, this could be beneficial if funds stay invested for the longer term in higher-risk growth assets (such as equities), rather than being deposited in a current or savings account, where they may be earning just a negligible rate of interest.

Taking too much too soon doesn’t just apply to the tax-free cash element of your pension. Evidence suggests many people are making the most of the pension freedom rules. Recent government figures show seven out of 10 people have taken a flexible payment from their pension before their 65th birthday — and this does not include those taking just the tax-free cash.

There may be perfectly good reasons to spend some of your pension savings, but make sure this is not at the expense of longer-term financial security, as that holiday of a lifetime may cost a lot more than you planned. 

• Read more on 5 money mistakes people make in their 60s

Failing to hedge against inflation

A woman aged 70 today is, according to the ONS life expectancy calculator, likely on average to live to around 88. There’s also a one in four chance she’ll live to 94 and a 1 in 10 chance she’ll reach the grand old age of 98.

With potentially 18 to 28 years of life still ahead of her, she has every reason to be planning for the longer-term. And that means keeping an eye on inflation.

Inflation is an indication of how quickly prices are going up. As we all know, the cost of living tends to go in one direction - and that’s up. Things get more expensive and the pound in your pocket buys you less as the years go by.

We’ve all been exposed to a very costly, real-life demonstration of how much of an impact inflation can have on our money over the past few years. Data shows that those £1,000 a month living costs of four years ago would add up to £1,223 a month today.

And if you’re on a fixed income, as pensioners are, finding that extra £223 a month or £2,676 a year isn’t always easy. However, it does have to be planned for. Otherwise, all that diligent decades-long saving into your pension could all too easily result in you finding yourself short of money.

Times have been particularly tough of late and while we’re not out of the woods yet, the latest drop in inflation suggests things will get better - although we may see a few more spikes in the inflation rate along the way.

We can’t second-guess those, but it is highly likely that in 18 - and in 28 - years’ time that £1,000 won’t buy you as much as it will today. When you consider that you could have a good few decades in retirement it’s really important that you try to keep your pension savings in line with inflation, so your money isn’t silently but slowly being eroded in value.

That might mean that cash and bonds aren’t necessarily the safer options you’d been led to believe they were. Without some money invested in stocks, equity funds or ETFs, the purchasing power of your retirement savings will likely decrease over time.

Keeping some of your savings invested in growth investments – such as funds that invest in company shares – can help your savings keep pace with inflation. There is risk involved – the value of shares can go up and down – but it's important to keep in mind that you could be using your retirement savings for the next 20 years or more. If stock markets do go down, there can still be time for them to recover, although this is not guaranteed, and you might not get back what you invested.

Not preparing for diminished capacity or later life care

You might not need it for years, but it can help to have a lasting power of attorney (LPA) in place for your finances and your healthcare, so someone trusted can take over your affairs if you are unable to do so  Arguably it is as, if not more, important than a will. Once you need one it’s often too late to set it up. So get yours in place as soon as you can.

Next to tackle is the issue of longevity, with more of us living a good deal longer than the traditional three score years and ten. It’s good news if those extra years are illness-free, but a very different story if we are one of the estimated three in four people who will require some form of later life care. Later life care isn’t cheap. Government figures suggest that one in seven people is expected to face care costs of more than £100,000 and one in 10 over £120,000. Saving these sort of sums is difficult, but many will want to factor this into their later life planning.

• Read more on 5 money mistakes people make in their 70s

Source:

¹Child poverty action group, December 2023

²Inflation calculator,  Wesleyan.co.co.uk, September 2024