One of the new pension changes that came into effect on April 6 is the reduction of the lifetime allowance from £1.25 million to £1 million. Saving £1 million may seem like an impossible goal, but with a lot of determination and aggressive saving you can get there!
Pensions are a particularly effective savings vehicle due to the generous tax relief on contributions, which is a huge incentive for many people to save. If you are a basic-rate tax payer the government will boost any pension savings you make by 20%, so if you put £800 away, you’ll have £1,000 in your pot after the tax relief has been applied.
But how much would you need to save to reach £1 million?
This is something we cover in a great amount of detail in a recent podcast regarding saving in a pension vs an ISA. We recommend you check it out!
Saving for a fund of £1 million
The figures given below assume:
- You aim to retire at 70 with £1 million in a private pension
- Annual fund management charge of 2%
- Investment growth rate of 7% pa
If you began saving at the age of 25 you would need to put away £393 per month, which would increase to £491 after 20% tax relief.
If you started at 35 you would need to save £701 per month, which would be boosted to £877. However, if you waited until the age of 45 to begin saving you would have to contribute £1,338 to your pension pot per month to reach £1 million.
It is important to bear in mind that these projections do not account for inflation, which can vary over time. Saving smaller amounts of money over a longer period of time can be more effective than saving larger amounts over a shorter period of time, as compound interest has time to work its magic and significantly boost your pot size. The Money Advice Service provides the following examples:
- If someone saves £200 per month for 20 years they’ll have around £75,000
- If someone saves £100 per month for 40 years they’ll have a pot size of around £123,000
The size of your fund is also dependent on the growth rate of your investments, so it’s important to review the performance of your pension to check it isn’t underperforming.
Tax implications of accessing your £1 million
You can access 25% of your fund tax-free and the remaining 75% will be subject to income tax. There is some confusion that tax is applied at a flat rate, but the size of your tax bill will be dependent on how much you withdraw from your fund. It is possible that you could be pushed into a higher income tax bracket and pay thousands of pounds more than you had anticipated, giving some of your hard-earned savings straight to the taxman.
The two scenarios that follow indicate how much income tax you could pay when withdrawing large sums of money from your pension and how you can reduce your tax bill by thousands of pounds.
- Peter is 70 and has retired with a pension pot of £1 million
- He has deferred the state pension and is not receiving an income
- He wants to withdraw £405,000 to invest in property
- He takes his 25% tax-free cash amount of £250,000
- The remaining £155,000 is treated as taxable income, pushing him into the additional income tax rate of 45% and removing his personal allowance
- His tax bill for the year is £55,893, and in addition to this Peter will need to consider the costs associated with investing in property such as stamp duty, capital gains tax and income tax on any rent payments
- Withdrawing smaller amounts over the course of a few years can significantly reduce the amount you owe the taxman. The following example shows how Peter could have saved £25,694.80.
- As shown in scenario 1, Peter takes his £250,000 tax free cash and has no other income
- He withdraws the other £155,000 over the course of 3 years
- In years 1 and 2 he takes £50,000 from his fund and pays £9,399.40 in tax for each year
- In year 3 he withdraws the remaining £55,000 and pays £11,399.40 in tax
- His total tax bill for withdrawing the same amount of £155,000, but spread over 3 years, is £30,198.20 instead of £55,893 for taking it all in one go
Often it is most effective to leave your fund in the wrapper of a pension and use it as a source of retirement income, so it is important that you talk to a regulated financial adviser before making any withdrawals. Portal Financial is one of the UK’s leading financial advisory firms and specialise in pension advice, they will be able to assist you with any questions you may have about your pension.
How much money are you hoping to have for your retirement and will you be relying solely on your pension?