In the UK news this week it has been reported that, for a comfortable retirement, people need to save a ‘pension mountain’ of £260,000.
Cue the doom-mongers and naysayers. ‘Who could ever hope to save this amount of money?’
Using the 4% rule this would give an annual income of £10,400. Doesn’t sound very comfortable to me.
So, how do we climb this ‘Mountain’?
The lifetime limit on pensions is currently just over £1m. Most people would expect £1m is more than enough to provide a gold-plated retirement of luxury.
Again, using the 4% rule, this would provide an annual income of £40k. Not exactly enough to buy a yacht, but more comfortable than just over £10k per year.
Obviously, the actual pension pot needed in retirement varies from person to person, but the general rule of thumb in the FI community is 25x annual expenses, with safe withdrawal rates (SWR) at 4%. Young Fi Guy delves further into SWRs here.
For simplicity, we’ll assume a person needs £40k a year for their expenses using 4% SWR. How much does this person need to save to get the £1m pension pot required?
Below I’ll set out the contributions needed to achieve that £1m, starting at different ages, calculated using Monevator’s compound interest calculator.
I have assumed that the pension is invested in the stock market (low-cost index funds?) and achieves a 7% annual growth rate. I’ve used the earliest point of being able to draw the money, currently 55 years old for personal pensions. Tax relief on contributions assumed to be at basic rate. (Gross contributions in brackets)
Age when start saving Net (Gross) Contrib./month /Year Final value at 55
20 £453 ( £566) £5440 (£6800) £1,005,811.00
25 £666 (£833) £8000 (£10000) £1,010,730.00
30 £1000 (£1250) £12000 (15000) £1,015,147.06
35 £1533 (£1916) £18400 (£23000) £1,008,899.07
40 2533 (£3166) £30400 (38000) £1,021,746.03
45 not achievable by 55 – max contribution £40k gross/y £591,343.97
50 not achievable by 55 – max contribution £40k gross/y £246,131.63
The above shows that around 40 years old is the limit on being able to achieve a £1m pension pot by the age of 55.
The key then to amassing a £1m pension pot is to start as early as possible, to allow compound interest to work its magic.
One interesting strategy, if you have children or grandchildren, could be to invest £5/day (£155/month) in a pension for them from birth until the age of 20. No further contributions would be needed for their pot to reach £1m by the time they are 55! What a fantastic gift that would make.
The investment strategies to get there yourself depends on your personal situation and risk tolerance. – The simplest option would be to invest into low-cost index funds via a SIPP, or you may take a high risk route and invest in the Dogs of the FTSE! You may have a company pension with little choice of funds. John at UK Value Investor outlines his proposed journey here.
When should we stop contributing to a pension?
The lifetime limit on pensions is currently £1,030,000.00. Anything above this is taxed at 55%.
So we need to monitor contributions and pension values to ensure it doesn’t go above this limit. The Escape Artist has a great post about getting on top of your pension situation – Do you even know what going on in your pension?
Below I’ll set out some maximum amounts we would want in a pension at certain ages, after which we don’t want to make further contributions to avoid breaching the lifetime limit.
Age Value when to stop saving Final value at 55
20 £95,000 £1,014,275.24
25 £135,000 £1,027,654.43
30 £185,000 £1,004,075.04
35 £260,000 £1,006,117.96
40 £370,000 £1,020,841.67
45 £510,000 £1,003,247.19
50 £720,000 £1,009,837.25
As you can see above, the figures are relatively quite small in the early years. So if a person had a windfall through an inheritance, or some other event, and was looking to invest the money in their pension it would be useful for them to keep these figures in mind so as not to contribute too much and end up breaching the lifetime limits.
In summary, a £1m pension pot is achievable, especially if you START EARLY.
What do you think?
Is a £1M pension pot unachievable for a normal person?
Are you aiming for a £1m pension pot?