A million pounds may be more than many people can hope to save in a lifetime, but it still isn’t what it used to be.
That’s because the amount of goods and services that it can buy you has shrunk over the years due to inflation – and will continue shrinking as we look forward1. People, broadly, are also living longer, so any money you have to live off has to last you longer.
In a previous article, we spelt out what it might take to become a pension millionaire. What follows below is a deconstruction of what a million-pound pension could get you in retirement.
While our analysis doesn’t account for other potential sources of retirement funding, such as untapped capital in the home or paid occasional work, we hope it gets you thinking about your own circumstances and how best to prepare financially for your own retirement.
This is because evidence from the government suggests that most people, despite auto enrolment in workplace schemes, are not on course to enjoy the kind of retirement they may hope for2.
At Vanguard, we are on a mission to try to change that.
How much retirement income do you want?
According to the Pensions and Lifetime Savings Association (PLSA), a ‘comfortable’ retirement – one that allows you to have a couple of holidays each year and to be a ‘little spontaneous’ with your money –requires an annual disposable income in today’s money of £37,300 per single person and £54,500 per couple3.
An annual income of £37,300, in terms of take-home pay, equates to about £43,500 of pre-tax pension income4, while £54,500 shared by a couple is almost £70,000 (if you’re relying on just one individual’s pot and are therefore subject to a higher rate of tax5).
The chart summarises what you might need based on the PLSA guidance. Remember: no national insurance is due on pension income.
Source: Vanguard calculations using online government calculator. *Assumes one pension pot supports two people. If spread across two pension pots, the income would likely only be subject to basic-rate tax, in which case the required gross total would be lower and closer to £62,000.
Is it enough?
The PLSA estimates are a useful marker. However, they still may not be enough for some people. Analysis by the Department of Work and Pensions (DWP), for example, suggests ‘high earners’ should target a retirement income that is at least half their current pre-tax income6. (This so-called ‘target replacement ratio’ is as high as 80% in the case of very low earners).
The good news is that people tend to need less money later in life – in part, because they no longer incur work-related costs, or have fewer dependencies and less debt to service, such as a mortgage, or because they can cut their overheads by downsizing.
Depending on your national insurance record, you’re also entitled to a state pension from your late 60s onwards7.
The bad news is that DWP data shows that as many as 89% of the working-age population are not on track to meet the PLSA’s definition of a ‘comfortable’ retirement, let alone anything higher. The DWP also says that high earners are the most likely to be ‘undersaving’ relative to their target replacement ratio of 50%8.
Hypothetical million-pound-pot scenarios
With that in mind, we’ve crunched a few numbers to see what a million-pound pension could provide. Two hypothetical scenarios are shown in the chart below. Each line shows how long a million-pound pension would last, depending on the amounts withdrawn each year.
To keep things simple, our examples assume that the pension holder draws a full state pension, which rises by 2.5% each year, and the required spend rises by 2% each year to account for inflation. We have also factored in the tax-free money that can be taken from a private pension under current rules (25% of the total up to a maximum £268,275) and assumed that the money left behind earns a 5% annual investment return after costs.
On this basis, we calculate that you would only need to withdraw money at a starting rate of £30,948 a year to achieve a total after-tax income of £37,300, including the full state pension. As the chart shows, this means a million-pound-pension could theoretically give you a ‘comfortable’ retirement as currently defined by the PLSA for as long as you need it and continue to grow the pot, ensuring you’re able to leave a bumper legacy.
Alternatively, if you’re looking for a higher net income of, say, £60,000 per year with an annual inflation uplift, a million-pound pension could last you around 23 years, as the second line shows.
How long a £1 million pension might last based on a retiree’s initial pre-tax annual income
Source: Vanguard calculations. Notes: Spending amount rises by 2% per year; average annual investment growth is 5% after costs; the full state pension is the investor's only other source of taxable income. We calculate the effective tax rate on pension withdrawals above this amount. Tax bands rise with inflation over time so the effective rate of tax an investor faces remains broadly the same as they escalate their withdrawals. The investor is able to withdraw up to 25% of their pension as a cash lump sum free from tax (up to a lifetime maximum of £268,275) - they do this gradually over time.
How long will you need a pension for?
Of course, some people may choose to spend more of their pension in the earlier part of their retirement, when they are more active, and spend less later. So assuming a constant rate of withdrawal like this may not ring true for everyone.
Even so, thinking about how long you might have to rely on your pension is a crucial consideration since people often underestimate their life expectancy, which means they can run out of money just when they most need it.
A female aged 50 today, for example, has an average life expectancy of 87 years and a one in four chance of reaching 94. Try the UK government’s online calculator yourself to see how long you might need a pension.
So play around with our pension calculator and get a sense of what your retirement might look like. Think about the pension money you’ve built up so far and whether you’re on course to retire when and how you want to. And if you’re not on track and are one of those many ‘undersavers’ identified by the DWP, ask yourself what you can do to help plug the gap.
Should you be increasing your workplace contributions? Could you be making more of employer matching9? Should you open a self-invested personal pension (SIPP) to bring together your older pensions and cut your costs?
Aim as high as you want to; it’s your retirement and you deserve it. Just remember that the longer you leave it to plug any funding shortfalls, the harder it will be.
1 The eroding impact of inflation is such that even with inflation of just 2%, a million pounds now left untouched would have the equivalent purchasing power of £552,000 in today’s money after 30 years.
2 Analysis of future pension incomes, Department of Work and Pensions, 3 March 2023.
3 Find out more on PLSA’s retirement living standards.
4 No national insurance is due on pension income, otherwise it would be more like £50,000.
5 If spread across two pension pots and subject only to basic-rate tax, the required gross total would be lower and closer to £62,000.
6 Analysis of future pension incomes, Department of Work and Pensions, 3 March 2023.
7 The state pension age will be rising to 67 from 66 over 2026-2028. The full state pension is currently worth £10,600 a year and linked to inflation. Check your own state pension forecast.
8 Analysis of future pension incomes, Department of Work and Pensions, 3 March 2023.
9 In addition to the statutory 3% of your pre-tax annual income between £6,240 and £50,270 that employers pay into your workplace pension, some will voluntary pay more into your workplace pension if you agree to increase your contributions too. Check with your HR department.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Eligibility to invest in a Vanguard Personal Pension depends on your individual circumstances. Please be aware that pension and tax rules may change in the future and the value of investments can do down as well as up, so you might get back less than you invested. You cannot usually access your pension savings or make any withdrawals until the age of 55.
Your pensions transfer will be sent to us as cash. During this period you will be out of the market (not invested) so you could miss out on any increase in the value of your pension fund should the market rise.
This article is designed for use by, and is directed only at, persons resident in the UK.
The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.
If you have any questions related to your investment decision or the suitability or appropriateness for you of the product(s) described in this document, please contact your financial adviser.
The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
© 2023 Vanguard Asset Management Limited. All rights reserved.