Turn your pension into a million pounds!

Find out why your pension could be worth a lot less than you think and how to turn it around.

How much money will you need when you retire? That’s the $64,000 question. But it certainly helps to have a rough target in mind, at the very least, or else how will you ever know how much you need to save?

Typically, the pensions industry will tell you to work towards one half to two-thirds of your pre-retirement salary. But a one size fits all approach doesn’t necessarily work here. It’s down to you to calculate how much you’ll actually need a bit more precisely.

Related how-to guide

Get ready to retire

There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.

See the guide

Of course, there’s a lot more to planning your finances in retirement than that. For a step-by-step guide on how to work out this magic figure, take a bit of time to read The four step guide to a comfortable retirement.

Why £100K is worth a lot less than you think

But, as well as overestimating our income requirements, on the other side of the coin, we also often overestimate how much income our pension pots will actually provide. This makes it even more difficult to make sure we’re saving enough during our working lives.

So, let me ask you this question: how much do you think a pension pot of say, £100,000 is really worth?

If it sounds like a pretty hefty sum to you, I’m afraid you’re already on the wrong track. Just check out the table below which shows you what a £100K pension is really worth in terms of providing you with a yearly income based on the most competitive annuity rate today (an annuity converts your pension pot into an income):

*Figure is for a joint life annuity and assumes both partners are 65.

Bit scary isn’t it? As you can see, a £100,000 pension pot might provide a 65-year old man with a fixed income of just £7,000 a year. In this situation, his income will stay exactly the same year in, year out which is fine as long as the prices of the items and services he needs to buy don’t rise!

If he wanted his income to keep pace with inflation, and rise in line with changes in the retail prices index (RPI), his income would plummet to just £4,336 in year one. Of course, he could expect it to step up in each year when prices rise. But, in return for protection from the effects of inflation on his purchasing power, he’ll have to accept a much lower income to begin with.

In the third scenario, if he wanted to provide his spouse with half his income after his death, he would have to take a lower income of £6,410 a year. Again this is a fixed amount with no inflation-proofing.

So, you can see a ‘whopping’ £100,000 in a pension pot might not stretch as far as you would hope.  

Turn your pension into £1 million!

This isn’t quite as preposterous as it might sound because, in certain circumstances, it is possible to turn a pension into a very healthy sum without spending an arm and a leg.

Now, just for fun, here are a couple of ways to reach a million quid:

• Imagine you’re in the lucky position of being just 18 and you can afford to save £170 a month. By the time you reach 70, your pension could be worth £1,007,379*.
• Now imagine your son or daughter is 10 years old and you start paying £102 a month into a pension on their behalf (around the sum you'll get in Child Benefit). When he or she is 18, they take over this relatively small monthly contribution themselves. By the time they reach 70, their pension could be worth £1,007,502*.

*These figures assume the following: the pension fund grows at 7% a year, annual charges of 1% are deducted, contributions increase by 2.5% a year. The figures have not been adjusted for inflation.

Recent question on this topic

• scousescot asks:

  I am a 48 year old female and can now save an extra £300 a month. Am I better to put it into my pension or some other saving?

  • 
    MikeGG1 answered "If you are a basic rate taxpayer, invest in a Low-cost All-Share Tracker ISA with, say, Legal &..."
  • 
    scousescot answered "Thanks. I'm a basic rate payer but my hubby is a higher rate payer and over 50 so I think it might..."
  • Read more answers

All I’m trying to demonstrate here is how compound growth over many decades can have a fantastic effect on the value of a pension.

But, on a more serious note, it’s unlikely you’ll need anywhere near £1 million to achieve the income you need in retirement (remember what I said about misjudging income needs?) But, at the same time, a seemingly healthy pension pot can fall seriously short if you’re not careful.

For a slightly more sensible calculation, let’s imagine you’re 30 today, you’ll retire at 68 and your target retirement income is £15,000 a year. Assuming you’ll still qualify for the full basic state pension at 68 - which today amounts to just shy of £5,000 a year - you’ll need to save £153 a month to achieve the other £10,000. And your contributions will need to increase every year to inflation-proof your pension pot. (This figure is based on all the assumptions shown above, and takes inflation into account at a rate of 2.5% a year).

If you want protect your yearly income in retirement from inflation then a bigger pension pot is required. This time you would need to save a higher amount of £206 a month. This will give you an initial income of £10,000 which rises in line with inflation every year.  

So, you can see, you don’t necessarily have to put away a vast fortune to reach your targets. But you do need a realistic idea of how far your pension pot will stretch to ensure you’re saving enough. You should also remember that these figures are only based on assumptions which could be very different from how your pension actually performs. For this reason, keep an eye on your pension planning to keep you on the right track.

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