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How to build a £1 million pension pot

Kyle Chubb | Wednesday 21st September, 2022

£1 million. In your pension.

For many, this will sound too good to be true. But in reality, a good number of earners can reach a £1 million pension pot in retirement.

Although it may sound daunting at first, with the right knowledge, intent and long-term consistency, it is achievable.

In this article, we’ll outline how you can give yourself the best chance of achieving a million pound pension pot. 

What does a million pound pension pot give you in retirement?

First, let's be realistic about what a £1 million pension pot actually means.

Of course, it sounds like a lot of money, and it is. But the real benefit to having a pension pot that size is financial freedom.

That's because it lets you be extremely flexible with your annual pension withdrawals - how much you take out of your pot each year in retirement. Here's how that might look.

A conservative retirement for most people lasts 25-30 years.

With a million pound pension pot, if you took our £50,000 a year via pension drawdown, you’d have 36 years before your pension ran out.

What exactly could this get you? A recent 2022 study conducted by ‘Which?’ found that “households with two people spent roughly £2,340 a month, or around £28,000 a year, on average, to be 'comfortable'”. 

For more context, the Retirement and Living Standards study deems an annual retirement income of £33,600 as comfortable. For a couple, it's £49,700/year.

This would cover all basic costs of living, totalling up to £19,000 per year on average, in addition to a few luxuries such as one European holiday, hobbies and eating out.

However, on £50,000 a year, you’d be looking at more potential luxuries, which could include multiple long-haul trips and a brand-new car every five years.

How long would a £1 million pension last?

table showing how long retirement would last with a million pound pension

"A £1 million pension would let you withdraw £50,000 a year in retirement for 36 years"

The power of compound interest

Understanding and applying the rule of compound interest is a vital if you want to achieve your million pound pension pot.

Compound interesr refers to the interest on a deposit, plus the additional interest accumulated over time. 

In other words, you can think of compound interest as the “interest on interest”.

In short, compound interest works on an exponential principle. This means that your pension pot sum will grow at a faster rate as time goes on. 

“The rate at which compound interest builds up depends on the frequency (i.e. time) of compounding. The higher the number of compounding periods (in our case of pensions, years), the greater the compound interest”.

This is in contrast with simple interest, which is calculated only on the initial deposit amount you start with.

Why starting today is so important

Let's assume you'd like to save £5,000 into your pension

If you add that money into your pension at age 40 and left it, by age 68 your pension would be worth roughly £20,000 (based on 5% annual return).

However, if you added that same £5,000 into your pension at 20, by 68 your pension would be worth £52,000 - more than double.

Thanks to time, you've got twice as much back for the same price. That's how powerful compound interest is.

Of course, your contribution amounts would hopefully increase each year, and the annual return rate would likely differ, but the overall point is this: the sooner you start, the harder your money will work.

line graph showing how compound interest affects capital growth over time

How to build a £1 million pension pot (step by step)

Ok, enough of the background information, how can you actually achieve a pension of this size? Let's break it down.

1. Start saving (today)

As a result of the compound interest principle explained above, the best time to start a pension pot was yesterday (as the saying goes). 

However, the second best time to start is today. Yes, literally as soon as possible. 

The sooner you start contributing money to your pension pot, the more you’ll be able to capitalise on compound interest working in your favour and accruing over time. 

Even if you can only afford small payments at this point in time, it doesn’t matter. Set aside an amount each month for your pension pot now and you can increase your payments later as your income rises.

What’s more, on top of reaping the benefits of compound interest, pensions are one of the best investments available as you get a free government top-up of at least 25% on your contributions.

For those of you working as an employee, you'll also get a free employer contribution of at least 3% of your salary each year.

So, the longer you wait, the more money you’ll be forgoing from the free government and employer top-up.

2. Stay consistent with contributions

In order to truly maximise your chances of reaching a million pound pension pot, you’ll need to make consistent contributions each year. 

This is, of course, a lot easier said than done. Unexpected life expenses and events appear out of seemingly nowhere, and if you’re not careful, they can completely shake your financial plans out of balance. 

However, the important thing is not to let all this put you off. Even if you’re making smaller contributions than in previous years - that’s completely ok. 

Try not to compare and judge yourself if this happens. Simply let it go and plan perhaps to contribute a larger sum in the following year. 

3. Consider investing in higher risk

This step is highly dependent on your investing strategy and overall attitude to risk.

Some investors prefer low-risk investments that simply keep up in line with inflation, whilst others are willing to take greater risks for a higher reward.

It’s important to note that higher-risk investments are likely to fluctuate more in value over time and thus may swing from being higher in value, to lower in value more often.

Therefore, your investment strategy is entirely down to you. However, if you’re starting your pension savings later on in life, it may be worth assigning a larger part of your investment portfolio to riskier investments in order to reach your million pound pension pot goal.

4. ‘Level up’ over time

Although paying into your pension pot while young gives you a fantastic start, an equally influential factor as you grow older will be the larger contributions you’ll be able to make as you earn a higher salary.

If you're employed, it's likely you'll pay a set amount into your pension pot each year from your job. If you can afford it, it's worth increasing the amount you contribute as you progress in your career.

This will further maximise your chances of reaching your million pound pension pot as fast as possible. 

Additionally, it might be worth increasing it as soon as you get a paid rise. This is so that you don’t accidentally spend the income that should’ve gone into your pension pot!

"You can pay up to £32,000 or 100% of your earned income into your pension each year, whichever is lower"

5. Combine your old pots

As it’s now a legal requirement for your employer to set up a pension scheme for you, if you’ve had more than one job it’s likely picked up a few different pensions over your career.

To keep on top of you savings, you may also want to consider combining your pensions into one plan.

This will give you a clearer idea of how much you have in your pension pot and how much further you have to go until you reach that £1 million mark.

6. Watch out for high fees

Depending on your pension scheme, you may also be faced with high or increasing fees over time.

Typically, the amount and type of charges for pension pots can vary, but most commonly, workplace pension schemes have the lower charges, whilst personal ones have the highest. 

However, this may not always be the case, so it’s important to conduct your own thorough research on pension fees before setting one up. 

The charges you pay are important because, while the performance of your investments can go up and down, you’ll have to pay the charges regardless.

Over time, charges can make a huge difference to your returns. Even relatively small differences in ongoing costs can add up over time. 

Ultimately, this could considerably hinder your chances of reaching your million pound pension pot, so please be ultra vigilant and fully check all fees. 

7. Delay your retirement (if possible)

The final yet arguably simplest of the steps listed is to simply work for longer. 

If you’re still struggling to see how you could reach your £1 million pension pot, it might be worth delaying your retirement and continuing to work for as long as you can. 

What happens if my pension pot is over £1 million?

Before embarking on your mission to achieving a million pound pension pot, there are a couple more key rukes that you should understand. 

One of them is the ‘lifetime allowance’. This is the limit on how much money you can build in your pension over your life whilst still enjoying the full tax benefits. 

For the majority of people, the allowance stands at £1,073,100. As of writing, this figure has been frozen at this level until the 2025/26 tax year.

It’s important to be mindful of this allowance as, if you go over it, you’ll have to pay a tax charge on the excess amount. More on that further down.

You should also be aware of the 'annual allowance' - how much you pay add to your pension each year.

As of writing, you can get tax relief on pension contributions up to £32,000 or 100% of your earned income each tax year, whichever is lower. Anything above this and you'll need to 'refund' any tax relief back.

However, there is one way you can pay more than the annual allowance into your pension.

If you've had a pension for a few years without hitting the annual allowance cap, you can 'carry forward' any unused allowance to make a large one-off contribution.

We explain how it all works in our guide to carrying forward your pension allowance.

Summary

Although it may seem like a daunting goal, a million pound pension pot is achievable.

Of course, many savers won't need to reach £1 million in their pot to retire comfortably. Your pension is a fantastic way to invest and save for the future, regardless of your goals.

To give yourself the best chance of decent-sized pension pot, you should try to stick to the steps outlined here. So that's:

  1. start now
  2. stay consistent
  3. consider higher risk
  4. increase contributions over time
  5. combine your pots
  6. watch out for high fees
  7. delay your retirement

The most important point is to start as soon as possible and break milestones into manageable and realistic smaller goals that you can follow on a month-by-month or year-by-year basis. 

The best way to help you do this is to use a fully-designed digital pension scheme such as Penfold. We’re an award-winning digital pension designed to help you take control of your savings and grow your wealth. 

Effortlessly combine old pensions into one smart plan, accessible anytime online or in our app. Finally, complete control over your pension future.

Some of our key features include:

  • Set up in less than five minutes
  • Easily find & combine old pensions
  • Top up, adjust or pause payments in a few taps
  • One simple, low fee

Ready to start your journey to a £1 million pension pot? Create your free account today.

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