What does it take to build a £1 million pension?

Many people have a dream of saving a million pounds for their retirement, even if a pot of that size will only be attainable by a lucky few.

It makes sense to make stretching targets when it comes to your retirement saving. Even if you eventually fall short, the effort is likely to leave your retirement finances in a much stronger position.

That’s important because - as we’ll explore here - even a £1 million pension pot will produce only a comfortable level of income in retirement, so any extra you can manage will improve your retirement prospects. And the good news is that there is some help which means the task might not be as difficult as you assume.

So what does it take to get there, how can you improve your chances and what can you expect if you achieve the magic £1 million pension pot? Even if you don’t feel such a large retirement fund is within your reach, read on - these are lessons that every saver can benefit from.

• See our current offers to help your money go further

How much do you need to save?

We won’t pretend that building a £1m pension pot is easy - the reality is that it will only be achievable for those with relatively high earnings who can save into pensions over many years.

But how much does it really take? The answer depends on the length of time you have to save and allow your pension money to grow with investment returns (remembering, of course, that the value of investments can also fall).

Here are some examples to reflect different situations people may find themselves in. We’ve used Fidelity’s Retirement Calculator to generate these numbers. Have a go for yourself - you’ll be asked a few simple questions about your circumstances and your expectations for retirement before the calculator gives you a projection of your likely retirement fund and the income it may generate.

Someone aged just 25 won’t receive their State Pension until age 68, giving them 43 years to build a pension pot. That’s great news because they have all that time to allow their savings to grow. Nonetheless, they would still need to contribute £835 a month in order to build a pot of £999,849 by the time they hit 68¹. To put it another way, assuming they were earning £40,000 age 25 - a good salary for someone so young - they would need to contribute a sum worth slightly more than 25% of their salary.

These numbers encompass a few assumptions that’s worth unpacking. Firstly, they assume pension contributions will grow as earnings rise - 1.5% annual pay growth above inflation is assumed. Secondly, we have applied a growth rate to their savings of 4.59% - that’s 5% investment growth minus 0.41% investing costs.

How about someone older who already has a sum of money saved? On the same basis as above. Someone aged 45 who already has £200,000 saved would need to contribute £1,505 a month to reach £1,000,211 by the time they reach retirement at age 68². Where they were earning an annual salary of £65,000, this would mean making contributions worth almost 28% of their pay.

Getting help where you can

Those are not small sums to be saving, and many will see them as unrealistic. But there are reasons why saving these amounts may not be as painful as you might think. First of all, pension contributions benefit from tax relief, so a payment into a pension will mean a smaller hit in terms of take-home pay.

Basic rate tax relief is added automatically, meaning an £80 contribution from your pay becomes £100 inside a pension, while extra relief is available for higher and additional rate taxpayers which - if not added automatically - can be claimed back through a tax return.

There may also be help on offer from your employer, who may be willing to pay into a pension on your behalf. Make sure you explore and maximise any help on offer.

Staying on top of your saving

The more visibility you have over your retirement saving, the more incentivised you’ll be to up your saving to keep things on track. But that isn’t always easy if your pension money is split across several places, as can happen if you’ve collected multiple pensions from different employers over the years.

It can really help to bring your retirement savings together in one place, bringing different workplace pensions together inside a Self-Invested Personal Pension (SIPP). Here you’ll be able to more easily see what you have saved, the investment return you’re achieving and then add to the amounts you're saving if that’s necessary.

• Find out more on transferring pensions to Fidelity

Getting the right mix of investments

Any investment return you get on your pension savings will help build your pot - and the higher the return the easier it will be to reach £1 million by the time you retire. It’s important to ensure you have the right exposure to assets with the potential to grow, even if this means the risk that they lose value for periods as well.

Assets like shares and bonds have a better track-record of providing returns ahead of inflation than safer assets like cash. They are more volatile, too, but if you still have many years until retirement you can afford to look past short term investment losses because you don’t yet need your retirement money. For this reason, you might want a higher exposure to shares.

Why not take inspiration from those who have already hit the magic £1 million figure with their retirement savings. We’ve previously highlighted examples of SIPP millionaires - you can read more about them here. What they all have in common is a split of investments skewed towards shares where the growth potential is highest.

If you’re saving into a workplace pension you may have been offered a limited choice of funds to save into. There may be options that allow you to invest your money more adventurously, but even default funds are likely to contain a high allocation to shares while you still have many years until you retire.

If you have pension savings in a SIPP, you have a much greater choice of how you invest. Make use of the guidance available to make your investment decisions - balancing the need for growth with your tolerance for losses.

As you get closer to retirement, it can make sense to dial down the risk in your retirement fund if you think you will need to access it, increasing exposure to safer assets like bonds and cash to head off the risk of sudden large falls.

What income will £1 million get you

There are now several possible ways to use retirement savings to generate an income and each has different implications for the income you can achieve.

You can read about the different income options here. These include buying an annuity - the financial product that takes your savings and provides a guaranteed income in return - as well as options that allow you to leave your money invested while you take income from them, including 'drawdown’ income and lump sums.

Both drawdown and annuity options usually allow you to withdraw 25% of your pension fund tax-free (up to a limit - currently £268,275), with income tax applying on the rest of the fund. If taking lump sums, 25% of each withdrawal is tax-free with tax payable on the rest.

And remember - you don’t have to pick just one method of accessing your pension cash - these options can be blended and changed over time to maximise your income tax efficiently. An adviser can help with that.

With £1 million saved into a pension, £250,000 would be available as tax-free cash leaving £750,000 to provide a recurring income. At current annuity rates, a 65-year old would be able to buy an income worth £39,285³. This would then rise by 3% a year to offset inflation.

If using drawdown, it’s up to you to decide a safe withdrawal rate. A commonly used rule-of-thumb is that 4% of a fund can be withdrawn each year, increasing with inflation, while leaving a high chance that the fund lasts for at least 30 years. On the basis of that, and after £250,000 tax-free cash has been taken, a drawdown fund of £750,000 could generate income of £30,000 a year.

Even if you’re not close to achieving a pension pot worth £1m - and most of us won’t be - it doesn’t mean that drawing up a plan to get you there is of no use. By maximising what you can save and getting your retirement plan in shape you might be surprised by how close to becoming a pension pot millionaire you could get.

The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

Source:

^1,2 Fidelity, Retirement calculator 14.10.24
³ SharingPensions.co.uk annuity rates 9.10.24

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.