Who wants to be a pension millionaire?

Working in financial planning at Tilney Smith & Williamson, one of the key areas that we focus on is retirement planning and whilst the role of a financial planner is to take a look at where a client is, where they want to be and how to get there, clients often approach me referring to funding their pension to a particular level.

There’s a big range of numbers targeted, but the one that always sticks out to people is the ￡1,000,000 mark. This certainly is a big number, but one that is absolutely achievable for many people with the right planning, investing and time horizon.??

What is the right planning for this? What is the right investment approach?

With investments there’s no one size fits all approach. Unfortunately with regard to how much risk to take, where to allocate the funds, which companies to invest in and where to loan your hard earned funds too there isn’t a prescriptive and blanket approach to everyone. As much as you want to get the best returns when investing, you also want to be able to sleep soundly at night and not expose a substantial sum of money to an unsuitable level of potential permanent capital loss.

On paper, it’s pretty straight forward. Start really early, invest your funds wisely and wait a really long time before starting to draw from your pension fund. Benefitting from compounded returns is absolutely the driving force of a well-funded retirement - and I mean it’s easy to do if you’re 18 years old with the capacity to invest ￡425 a month at a 5% annual return over a 49 year period – but what about the rest of us?

If you’re a 35 year old just looking to get started on your pension planning, annual contributions of ￡12,650 yielding 5% annually will achieve a pension pot of c. ￡1 million by age 67.

If that same individual was to delay things a further 10 years and begin saving for retirement at age 45, annual contributions of ￡24,750 yielding 5% annually would achieve a pension pot of ￡1 million by age 67.

A 55 year old looking to come to the game later and fund that same pension pot would need ￡60,000 per annum. However, this is well in excess of the ￡40,000 annual allowance and would require alternative options – likely establishing a separate portfolio using ISAs or a taxable investment account which would not benefit from tax relief in the same way.

So, what is the overall cost of this? For the purpose of this example, I have assumed that our individual is a higher rate taxpayer and therefore benefits from 40% tax relief on the contributions made.

So as well as an increased annual burden to achieve the target funding of ￡1 million, it’s significantly more expensive over the long-term.

So what does a ￡1 million retirement pot mean for clients?

Well, clients can take 25% of the fund as a tax free cash withdrawal, so that pot would provide a one of lump sum of ￡250,000. For the sake of simplicity, let us assume that the client wishes to take it all in one lump sum and spend it on a holiday home.

Assuming clients benefit from the full state pension entitlement, they would receive ￡179.60 per week or ￡9,339.20 per annum. Historically, actuaries and financial advisers have worked on a sustainable drawdown rate of 3.5% to 4%, noting that a retirement pot may need to last 25 years, and if we go down the middle of this and assume a drawdown rate of 3.75%, an individual would be able to draw a further ￡28,125 per annum. Combined with the state pension entitlement, this would leave a gross taxable income of ￡37,464.20. After paying the relevant income tax, we are looking at a net income of ￡32,485.36 or ￡2,707.11 per month – whilst a fantastic retirement income and more than sufficient to have a good lifestyle for many, it’s certainly a long way from the millionaire lifestyle that ￡1 million retirement pot had suggested!

There’s certainly ways to improve this – for example, let’s say that our client had chosen to be more frugal with the ￡250,000 tax free cash entitlement, and chosen to invest this in a tax-efficient manner and provide a further pot to draw from at a rate of 3.75%. That’s a further ￡9,375 a year or ￡781.25 per month, bringing us to a monthly income of ￡3,488.36.

With the average UK pension pot just ￡49,988[1], as a population we owe it to our ‘future retired selves’ to dust off those annual pension statements we have let pile up and move our pensions further up the list of priorities. For most people, it’s their second biggest asset after their home, but it’s certainly one of the ones given the least love and attention on a regular basis. After all, taking a look today could save you hundreds of thousands of pounds and make a massive and truly tangible impact on your lifestyle in retirement.

As the Chinese proverb goes, the ‘The best time to plant an oak tree is twenty years ago. The second best time is now and one area in which this rings true is certainly your pension planning. If there’s one bit of advice that applies to everyone, it’s that taking action and getting to grips with your pensions today will get you going along the right lines.??

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

Capital at risk. The value of investments and the income from them can fall as well as rise and the investor may not receive back the original amount invested. Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. Clients should always seek appropriate tax advice before making decisions.

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[1] https://www.aegon.co.uk/content/dam/ukpaw/documents/readiness-report-2017.pdf