Beware the pension mistake that leaves millions unable to cover essential costs: RACHEL RICKARD STRAUS

I know you’re going to think me a party-pooper for what I’m about to say, but hear me out.I’ve been speaking to pension experts who tell me there is one mistake most of us make that could seriously derail retirement – but you’re not going to like hearing it... or the remedy.

Forecasting and analysis firm Oxford Economics will reveal in a report today that 92 per cent of households should be able to cover their essential costs in retirement.That’s the good news – and is largely thanks to the state pension, which provides the backbone for most incomes in older age.Now for the bad.

Those who take their tax-free lump sum and spend it on anything other than creating an income stream in retirement will see a big hit to their lifestyle when they do finally retire.The report estimates the proportion of households able to maintain their lifestyle in retirement is eight percentage points lower for those who take theirs than households overall. Tempting: The option to withdraw 25% of your pension pot tax-free up to a £268,275 cap from the age of 55 (rising to 57 in 2028) is one of the most-loved tax perks aroundHigher earners who take their lump sum are the worst affected because their personal pension – from which the tax-free chunk is taken – forms a greater proportion of their retirement wealth.

I’m hardly going to win friends by telling you not to take yours. The option to withdraw 25 per cent of your pension pot tax-free up to a £268,275 cap from the age of 55 (rising to 57 in 2028) is one of the most-loved tax perks around – a well-earned reward for decades of gruelling delayed gratification. RELATED ARTICLES Previous 1 Next Renting can swallow your pension so you're better off...

Surge in demand for annuities as retirees look to swerve... Share this article Share HOW THIS IS MONEY CAN HELP What you need to know about money every week: This is Money podcast Millions use it for something enjoyable, such as buying a new car, going on a bucket-list holiday or redoing the kitchen.Such luxuries are hard to pay for solely out of income while you’re working.

Many need their lump sum to pay off debts or clear the mortgage ahead of retirement.But Helen Morrissey at investment platform Hargreaves Lansdown, which commissioned the report, warns that taking it ‘is a bigger decision than most people realise’.‘People should consider the fallout on their retirement income before going ahead,’ she adds.

‘Thousands take their lump sum when they don’t have an immediate need for it and put it into a savings account where it earns a low return. It could be earning much more if left invested in a pension.’There’s no reason why you can’t take your tax-free lump sum over time or delay it until you need it, but it would take a fundamental change in mindset.

Withdrawing it in full has become the default decision, perceived as a no-brainer, according to a report from the Pensions Commission in May.As many as 83 per cent of people accessing their defined contribution pensions since 2015 have taken a lump sum from at least one of theirs.The Institute for Fiscal Studies think-tank blames the name.

It says we should change it from tax-free ‘lump sum’ to tax-free ‘element’, so it’s no longer seen as something to take all in one go. Will would-be PM Andy Burnham and his new Chancellor pledge not to touch the tax-free lump sum this parliament?Not the catchiest name, but you can hardly blame people for thinking they should take their tax-free cash as a lump sum when it has ‘lump sum’ in the name.

Would-be Prime Minister Andy Burnham and his new Chancellor could help, too. Lump sum withdrawals surged ahead of last year’s Autumn Budget amid fears the Labour Government was poised to slash the perk. Savers withdrew a colossal £3.

9billion in pension lump sums in the 12 months to October, according to official figures – up 81 per cent compared to the same period in 2022/23.Burnham could stop this from happening again by pledging not to touch the tax-free lump sum this Parliament.Finally, maybe we all need to reframe how we think about the lump sum.

By not taking it immediately, we’re not giving something up but instead ending up with more money to spend overall. Helen Morrissey, retirement specialist at investment firm Hargreaves Lansdown, says that tax-free lump sums could earn more if invested in a pension rather than in a savings accountSay you had a £400,000 pension pot and withdrew 25 per cent as a tax-free lump sum to stash in a savings account earning 3 per cent interest a year. You could have about £134,000 by the time you retire ten years later, according to calculations by wealth manager Broadstone.

If your remaining pot kept growing at 5 per cent a year, after ten years it will have reached £448,688, giving them a combined value of £582,688.However, if you had left the entire £400,000 pension pot to keep growing until age 65 without taking any tax-free cash, it could reach £651,558 – an extra £68,870.You would now also be able to withdraw a consi