Having a pension pot of £1million sounds lovely, doesn’t it? That truly is a lot of money. We all dream of retiring early and doing the things we have always wanted to do. Indeed, a million pounds would allow that to happen.
Well, not necessarily.
Remember that everyone is different. Everyone has different circumstances, wants, needs, requirements.
Imagine if Cristiano Ronaldo was given £1m at age 55 to go and enjoy retirement? It would barely last a day. But of course, to most of us, this would be plenty if used correctly.
Let’s examine the possibility of achieving a one-million-pound pension and the implications for retirement.
How can I reach a pension pot of £1million?
There are two critical factors to achieving a large pension pot. The first is to save regularly. Nowadays, most employees are auto-enrolled into company pension schemes and contribute this way. That is brilliant because it forces you to save for your future, but your employer will also contribute.
However, for most average earners, this alone won’t be enough to achieve a million-pound pension pot unless you are in a final salary pension scheme. For this, you will likely require a separate pension pot. This could be a personal pension or a SIPP, for example.
You can contribute to your separate pension savings plans and benefit from tax relief. Any pension contributions you make will be ‘grossed up’ so that your pension balance will increase by more than the amount you contributed.
The other key factor to reaching a 1 million pension pot is starting early. Too many people think that retirement is so far away that they won’t bother saving for it. Spending money now seems too attractive, and saving for the future is hard to comprehend.
This means that most of us reach 40 or 50 and suddenly realise we need to focus on retirement savings. This is not necessarily too late, but the amount you need to contribute is far higher because you are playing catch-up. Furthermore, you have fewer years of investment growth to benefit from before you start drawing benefits from your pot.
Starting your pension pot at age 20 would require around 4 times fewer monthly contributions to reach a £ 1 million pension than starting at age 40. That means if you start putting away money when you are 20, the amounts will be relatively menial and not affect your standard of living. You will also get used to taking this money off your monthly salary, so you will factor it into your lifestyle. Whilst enjoying the full tax relief on the contributions you make.
The alternative is to have a lifestyle that doesn’t involve retirement savings and then get the shock at age 40 that you suddenly need to contribute vast monthly sums to have sufficient savings.
So there you have your key lessons. Contribute regularly, and start early.
Is £1m a big enough pension pot to retire with?
Answering this question is akin to saying how long a piece of string is. This very much depends on your individual circumstances. Using extreme examples, if you spend £100,000 a year now and plan to carry that on in retirement, your pot won’t last very long. But if you only spend £10,000, a million should be plenty!
The important point is that you shouldn’t assume that just because one million pounds sounds like a lot, it will be enough. We generally live much longer than we used to, so it is worth considering that you could live well into your 90s or beyond.
One solution to this question could be to jot down rough figures and estimates for how much you might spend, how much other income you have, and various other assets you may hold. This could give you a vague idea of whether a million pounds is enough to retire. But do you want to base your retirement and wealth on a vague idea?
Instead, you should make use of cash flow planning. This is a service that some financial planners, including us, use with their clients to forecast their financial future. Your entire financial picture can be inputted and simulated using intelligent software. These simulations factor in all the various aspects, such as state pensions, inflation, investment, pension lifetime allowances, growth and tax.
Not only does our cash flow system give you one simulation, but it gives you hundreds. These are based on historical data, so you know they are real-life scenarios from the past. You are then presented with a chance of success using these hundreds of scenarios. The chance of success is calculated based on the percentage of scenarios in which you still had money when you died.
Since the question posed cannot be answered simply because everyone is different, we highly recommend that you seek financial advice. This is the only way to be confident that your pension pot will be enough.
How much income can I take with a £1m pension?
You build up that pot by taking retirement income from your pension. Once you retire, the first stage is to figure out how much pension income you need and then assess whether you have enough for this amount.
If you were to retire at age 55 and live to age 95, that is 40 years of retirement. For simplicity, assume you do not invest any of your pension. You could take £25,000 per year as income for 40 years. In reality, you could take more than this because you would have it invested, but there is also inflation to factor in. Of the £25,000 per year annual pension, 25% would be tax-free, and the remaining would be taxed as income, so you would be left with less than that.
However, should you work until age 67 and only live until age 87, that is a 20-year retirement. Suddenly, you can earn £40,000 per year before tax using the same assumptions as before.
The difficulty here is that you don’t know how long you will live for. You also don’t know how well your investments will perform. You also don’t know how high inflation will be and how much it will eat away at your money.
These uncertainties make the question very difficult to answer with any certainty. That is why cash flow forecasting is helpful to give you many different figures that can provide an average. As long as your financial plan and cash flow forecast are revisited each year to account for changes, you can keep on top of your money and make sure you do not run out.
What if I buy an annuity with a £1million pension?
Annuities give guaranteed income for the rest of your life in return for a lump sum at the start. The income you are paid is dependent on interest rates at the time of purchasing your annuity. In recent years, interest rates have been at record lows; therefore, annuities have not been very popular. People have found that investing their money and managing their income is far better.
However, that has started to change since interest rates have increased dramatically since the start of 2022. Annuities are suddenly back in the conversation.
The huge benefit of having one is that it is guaranteed forever. You can even purchase some that will pay your spouse an income after you die. Some can be increased each year with inflation so that the purchasing power of your income is maintained over the long term.
Purchasing an annuity with a pension pot of £ 1 million at age 55 would generate approximately £35,000 annually. If you are buying one at age 65, this would increase to around £45,000 per year.
These are significant amounts, considering they will keep paying until you die. Even if you break world records and live to age 150, you will still receive your £45,000!
But would you get a higher income if you invested in your pension and used the pension drawdown? It is not likely that you will live until age 150, but that is the question for most people.
Summary
To most people, one million pounds is a very significant amount of money. On the face of it, this sounds like enough money to live on in retirement. But once you start factoring in a long life and high spending, this can quickly dwindle.
The key takeaway is that you must decide how you want your retirement to look. When will it start, how much will you spend, are you in good health? These questions will be essential to paint that picture.
Once you know the answers, you can come to us and benefit from our cashflow planning service. That will give you peace of mind that your plan is on track and you shouldn’t run out of money. As your financial adviser, we are here to help you and ensure you do not outlive your wealth.
