Who wants to be a Retirement Millionaire?

Who wants to be a Retirement Millionaire?

Although (hopefully) readers here will be aware that they don’t need an enormous pension pot to retire; reaching a cool million still remains the goal for many others. What better feeling than hitting that 7 figures? However there are several things to consider before you get knocked over with a huge tax bill at the end.

As the pension freedoms were introduced back in April, there also came a controversial announcement of a reduction in the lifetime allowance – from £1.25 million down to £1 million. This change will come into effect from the 2016/17 tax year, so for those of you looking at trying to reach the £1 million goal for the future, it will impact you.

Lifetime Allowance

The lifetime allowance is essentially a limit to on the amount of pension benefit you can draw from your pension scheme without triggering an extra tax charge. It was first introduced in 2006, at a level of £1.5 million and rose to £1.8 million in 2010, before its gradual reduction. The lifetime allowance does not affect most people in the UK, though if you do aim to put a plan in place to reach £1 million for retirement and want to ensure you’re not hit with hefty tax bills it’s important to monitor your savings to know when you’re close to the limit. This may mean taking your pension earlier even if you’re not ready to retire from work, or stopping your contributions.

Making a Million

So how do you go about making a million to retire with?! Well, obviously working hard, succeeding at work and investing wisely are always good rules to live by when thinking of your financial future. But there are other things to be aware of too.

Starting as early as you can is also going to give you a bigger head start for when retirement comes; Remember, it’s a marathon, and not a sprint.

Let’s assume you want to retire at 70 years of age, you have an annual fund management charge of 2% alongside an investment growth rate of 7% per annum.

Pensions are a great savings vehicle, particular since the auto-enrolment of workplace pensions started to roll out across the country. Your employer and the government now have to boost your pension contributions with a subsidisation of their own. So if you wanted to reach £1million by the time you were 70, here’s what you’d have to save per month into your pension:

Age 25, £393 per month – With tax relief, this would be boosted by 20% to £491.

Age 35, £701 per month – this would increase to £877.

Age 45, you would have to contribute a whopping £1,338 every month in order to reach a pension fund of £1 million by the time you reach 70 years of age.

Obviously this does not take into account changing interest rates and inflation, which are likely to vary over time. It’s also only taking in the simplest savings method of monthly investment into a workplace pension scheme.

The Money Advice Service provides examples to show just how compound interest can work wonders:

  • Saving £200 per month for 20 years will yield around £75,000
  • Saving £100 per month for 40 years will yield around £123,000

Using the little and often method, rather than making bigger contributions over a shorter space of time, can be a lot more beneficial for you.

Savvy investors can use the assistance of a financial advisor to invest in riskier stocks which could lead to much higher returns, ultimately reaching that £1 million goal much earlier – though this can also go the opposite direction and leave you destitute if you aren’t careful or you take too many risks.

Tax Implications

If you’re saving early to try and reach the £1 million pension mark, some of the rules around tax will likely have changed by then. But as it currently stands, should you want to withdraw from your pension fund you are entitled to take the first 25% tax-free.

Anything over this will be taxed at your marginal income rate, E.G. anything under £10,600 per year is tax exempt, £10,601 to £31,785 is taxed at 20% (basic rate), and withdrawing over this will trigger a 40% tax rate. There is also a higher rate of 45% for those earning (or in the case of pensions, withdrawing) over £150,000 per tax year.

To avoid creeping into a higher tax band, you can keep track of your withdrawals each year and attempt to stay below the threshold that 40% tax is triggered at.

It can also be more effective to leave your cash invested through the method of income drawdown, as it can continue to see growth over your retirement.

 

Will you be affected by the lifetime allowance? Or are you making preparations so you don’t get hit by a hefty bill in the future? Let us know in the comments below.

6 thoughts on “Who wants to be a Retirement Millionaire?

  1. 2% charges sounds like a lot. I know the rules are different in all countries, but couldn’t people in the UK just save that money in other accounts (e.g. Vanguard, etc…) where the fees are closer to 0.5% a year? That would make a huge difference towards the goal

      1. You don’t need to invest direct with Vanguard, you can just invest in their funds through most UK platforms. The cost for the Vanguard Lifestrategy 80% (which I invest in) is only 0.24% and then you add on whatever the platform charges you. Other Vanguard funds are even cheaper.

  2. Nice post, Guy. I had not actually thought about that change when it was announced. It seems so distant that it had not registered on my radar. As you say, they are likely to change (for better or worse) between now and when I retire.

    At present, most of my ‘retirement’ funds are in an ISA rather than a pension. The chief reason is that it is accessible if I need some in the short term and I am not currently able to max out the ISA every year. However, if I ever get into the higher tax bracket and/or max out the ISA I will certainly start filling up a SIPP. My work pension–at present–is limited. Though it will grow, of course.

    It is definitely something to be aware of as retirement approaches!

    PS: I agree, 2% does seem extremely high!Vanguard is quite hard to lay your hands on sometimes, however. One of my brokers does not seem to deal with them, the other does. Infuriating!

  3. I’m another Vanguard fan and, depending on the platform for your ISA and SIPP, the total charges could be around 0.5%. Chopping the charges by 1.5% each year would save you THOUSANDS. Definitely worth switching.

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