Nearly two million British households will spend more than £1m during their retirement, new analysis shows.
This sum includes essential spending on housing, energy bills and food, as well as holidays and other leisure. Increasingly for this wealthier group of pensioners health care costs must also be met.
Post-retirement spending will be funded from a variety of savings and investments – from Isas to pensions, including those offered by the state, through an employer or built up privately.
Even though the amount you can save annually into a pension has been cut dramatically in recent years – from a high of £255,000 in 2010-11 to £40,000 today – that still gives more than enough flexibility to save £1m into a pension by 65 for those with the spare cash to put aside.
A report published by Tilney, a financial advice firm, used Office for National Statistic figures to calculate how much households spend at various stages of their lives.
The analysis shows the richest 6pc will spend £1m in retirement, while the top 25pc spend £683,000 and even the average household will spend £420,000.
These are daunting figures, but following Telegraph Money’s five tips, a £1m pension pot is achievable even for those on more modest salaries.
1. Start early
As with all investing, the earlier you start the easier it is to reach your target. The magic of compounded returns means putting away small amounts for a longer period, normally beats saving larger amounts over a shorter amount of time.
Figures compiled by Prudential, the insurance company, assuming 4pc annual returns, show a 25-year-old, higher-rate taxpayer would be able to build a pot of £1m by age 65 by saving £506 a month. For a basic-rate taxpayer the monthly saving rises to £675 because tax perks on pension savings are less generous the lower your income tax bracket (see tip 2, below).
If individuals wait until the age of 45 to start saving, a higher-rate payer would need to save over three times as much – £1,630 – to hit the £1m target by 65. For a basic-rate payer the figure is £2,174. Bear in mind, however, that even modest inflation over the years will drastically reduce the spending power of £1m in today’s money.
2. Claim tax perks
The big advantage of saving through a pension, compared to an Isa, is the tax relief offered by the Government. Most people can save £40,000 a year into a pension and receive these perks, beyond that you can keep saving but it will not receive the tax relief uplift.
Tax relief is based on your income tax bracket.
So, a basic-rate, 20pc, taxpayer pays £80 to make a £100 pension contribution. A higher-rate payer only needs to pay £60 to make the same pension contribution. You can only save as much as you earn in a year inclusive of the tax perks. This means someone with a £35,000 salary would be able to make contributions of up to £28,000 of their own money, with £7,000 added from basic-rate relief.
Even non-taxpayers – those earning less than the £11,500 personal allowance – can use tax relief to boost their contributions.
They receive relief at the basic-rate, 20pc, up to an overall limit of £3,600 a year (including tax relief). Tax relief can supercharge your saving but only if you claim it. While a pension offered through your employer will often have the correct tax relief applied, self-invested personal pensions (Sipps) will not.
These providers typically claim basic-rate relief automatically, but it is up to higher earning individuals paying 40pc or 45pc tax to claim the extra relief through their tax returns.
This money will be returned directly to you by HMRC and so will only end up in your pension if you put it there.
3. Invest for growth
Simply putting money into a pension is unlikely to be enough to grow your pot to the £1m mark.
Investment growth is key, particularly in the early years of saving when you should have a greater tolerance for swings in the value of your pension.
Jordan Sriharan, of Thomas Miller Investment, recommended the Neptune UK Mid-Cap fund, which returned 126pc over the last five years. The fund’s biggest holding is ITE Group, a conference firm operating in fast-growing countries including Russia, China and Africa.
Tilney’s Jason Hollands suggested several “one-stop-shop” funds that take care of the asset allocation and give exposure to a broad range of stocks across the world.
He picked out three listed investment trusts: Foreign & Colonial (total return of 87.4pc over five years); Scottish Mortgage (174pc) and RIT Capital Partners (61.5pc).
If you are saving through a work pension and you have not made an active decision, you will be placed in a “default fund”. It is important to see exactly what these funds invest in to make sure they are suitable.
Many are designed to match annuity prices. This is because before the landmark pension reforms in April 2015, most people bought annuities with their pensions.
Consequently, the funds automatically buy lower-risk assets such as bonds and cash a decade or so before a fixed retirement date, this is likely to limit the growth in your pension severely in later years – although it should reduce the amount the value fluctuates.
4. What’s your employer offering?
Since 2012 companies have been required to save into a pension scheme on behalf of any staff earning at least £10,000 a year. At the moment the legal minimum they must contribute is 1pc, rising to 3pc from April 2019.
But studies have shown saving at these levels is extremely unlikely to produce an adequate pension. Many companies offer more generous contributions if you save more – matching what you add, up to a cap. Some firms will even offer “non-contributory” pensions where staff do not have to save anything themselves.
Check your employer’s benefit package as the generosity of pension schemes may not be widely publicised.
Increasingly, employers provide pensions via “salary sacrifice” arrangements where pension contributions are made in lieu of salary. This results in a saving on National Insurance payments for both you and the firm – some companies share their savings with staff.
5. Don’t forget the state pension
Personal and work pensions are unlikely to be the only source of income when you stop working. The guaranteed payments provided by the state pension are the bedrock of many people’s retirements.
For those retiring after April 2016 the new “single tier” state pension applies. This replaced the old system of basic and earnings-related payments. You must have a minimum of 10 qualifying years of National Insurance Contributions (NICs) to get a state pension.
The maximum pension you can get currently is £159.55 a week if you have 35 or more years of NICs. If you have gaps in your record that would take you under 35 years these can be filled.