BUILDING up a pensions pot worth a million pounds sounds like an impossible dream, particularly for those of us earning average salaries.
But Darren, a 56-year-old retail worker from South Yorkshire, managed to save a nest egg of over a £1million on a modest salary.
We explain how by saving early, taking advantage of company matching opportunities and benefitting from compound interest he managed to do it.
A pension pot worth a million pounds could get you a guaranteed annual income for life of around £37,700 each year, according to the MoneyHelper.co.uk.
That figure assumes that you've already taken your 25% tax-free lump sum.
Of course, how much you'll actually need for retirement depends on a lot of factors including the lifestyle you want, how much you earn now, and whether you own your property or will need to pay rent.
What are the different types of pension?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (Sipp) – This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension – The Government has made it so it's compulsory for employers to automatically enrol you in your workplace pension, unless you choose to opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won't be able to change it. Minimum contributions rose to 8% in April 2019, with employees now paying in 5% (1% in tax relief) and employers contributing 3%.
- Final salary pension – This is a also a workplace pension but here, what you get in retirement is decided based on your salary, and you'll be paid a set amount each year on retiring. It's often referred to as a gold-plated pension or a defined benefit (DB) pension. But they're not typically offered by employers anymore.
- New state pension – This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £179.60 a week and you'll need 35 years of national insurance contributions to get this. You also need at least ten years' worth of national insurance contributions to qualify.
- Basic state pension – If you reached the state pension age on or before April 2016, you'll get the basic state pension. The full amount is £137.65 per week and you'll need 30 years of national insurance contributions to get this. If you have the basic state pension you may also get a top-up from what's known as the additional or second state pension. Those who have built up national insurance contributions under both the basic and new state pensions will get a combination of both schemes.
As a general rule of thumb, experts say you should aim to have savings that provide an income worth between half and two-thirds of your annual salary.
Consumer experts Which? estimate that a couple needs at least £757,000 in pensions savings to have a retirement lifestyle that includes annual long-haul holidays and a new car every five years.
It says that a couple would need to have £305,000 saved to have an income of £19,000 a year from an annuity, which would allow fora “comfortable” life — including holidays to Europe; visits to pubs and restaurants; Sky TV and days out.
We spoke to Darren to find out how he achieved his goals and his top tips for savers at every stage in the retirement savings journey.
Start little and early
One of Darren’s biggest pieces of advice for anyone who wants to build up a decent retirement fund is to get saving as soon as you can, even if you can only afford small amounts.
He started when he was in his twenties, meaning he now has over 30 years of contributions, not to mention compound investment returns.
He says: “Back in the 90s, when I was around 25, there was an opportunity to save into a private pension and I took it.
"I was only putting in about £10 or £20 a month though, so not a lot. I didn't really think much about the contribution because I was used to not having it.”
Despite only saving a small amount into that early pension, it’s now worth over £30,000, showing just how much money can grow when it’s invested in a retirement fund for a long period of time.
He adds: “I was putting away such a small amount that I didn't remember it, it was like yet another tax deduction. So even a small amount can really add up over time.
"If I had known as much as I know now 40 years ago, I'd probably put 50 grand in an investment and it would probably be worth more than a million pounds by now, just because of the gains.
"Just a little bit can turn into so much because the compound interest is such a major factor.”
Take advantage of company schemes
Darren had the opportunity to save into a final-salary pension, where he contributed 8% of his monthly income, and his employer contributed 16%.
These gold-plated defined benefit (DB) pensions offerings are particularly good because the amount you get at retirement is based on how much you earned, rather than how well your investments do.
DB pensions are rare these days, unless you have a job in the public sector, for instance as a teacher or in the civil service, but that doesn’t mean you can’t benefit from your employer and the government to boost your retirement fund.
Anyone older than 22 who earns over £10,000 a year from one employer gets auto enrolled into a company pension scheme.
Under this scheme, you contribute 5% of your salary, and your employer puts in 3% on top.
That means for every £10 you pay in, you’ll get a bonus worth £6.
You also get tax relief which means that some of the money you would have paid the government in income tax goes into your pension instead.
Many employees may be able to boost their income further thanks to something called "company matching".
Lots of firms have rules where if you put extra money into your pension, then they will match it, meaning your savings grow far more quickly.
Some of the best schemes available even offer to pay in twice what you do up to a certain limit.
Check your pension rules carefully to see if you can benefit from this free cash. Even if your employer doesn’t match, you still benefit from tax relief if you pay more in.
Darren maximised his chances of a decent retirement by making Additional Voluntary Contributions (AVCs) throughout his working life.
These AVCs work similarly to modern defined contribution pensions, where the more you contribute, the more you get out, and your final pot size will depend on how your money grows.
He says: “I had one career for 39 years. The opportunity to join the pension scheme was the biggest decision for me and then obviously the AVCs was the second biggest because it gave me a chance to build up my pot.
"For younger people today, to be auto enrolled is really important. That will give them a kickstart to thinking about how their money can make more money.
"That's the bit you can enjoy, if you save enough in the pot.”
What is pensions auto-enrolment?
HERE’s what you need to know about pensions auto-enrolment:
What is pension auto-enrolment?
Since October 2012, employers have had to enrol their staff into workplace pension schemes as part of a government initiative to get people to save more for retirement.
When does auto-enrolment apply?
You will be automatically enrolled into your work's pension scheme if you meet the following criteria:
- You aren't already in a qualifying workplace scheme.
- You are aged at least 22.
- You are below state pension age.
- You earn more than £10,000 a year
- You work in the UK.
How much do I contribute?
There are minimum contributions that you and your employer must pay.
Your minimum contribution applies to anything you earn over £6,136 up to a limit of £50,000 (in the tax year 2019/20). This includes overtime and bonus payments.
A minimum of 8% must be paid into the pension, with you contributing 5% and your employer paying at least 3%.
What if I have more than one job?
For people with more than one job, each job is treated separately for automatic enrolment purposes.
Each of your employers will check whether you’re eligible to join their pension scheme. If you are, then you’ll be automatically enrolled in that employer’s workplace pension scheme.
Can I opt out?
You can choose to opt out, but you’ll miss out on the contributions from the government and from your employer. If you do choose to opt out you can opt back in later.
Grow your earnings
Another factor that helped Darren to build up his pension was increasing his income throughout the years, which he says was a result of volunteering to relocate regularly for the supermarket he worked at.
His higher income not only meant that his Defined Benefit pension was worth more overtime, but also that he could afford to make more voluntary pensions contributions as he approached retirement.
He says: “When I started at sixteen, I was earning about £13.95 a week, and I remember after Christmas it went up to about sixteen pounds.
"I got my first start in a supermarket at sixteen, but at 18 I went to a college in London as they put me forward for a managerial course.
“When I ran my first ever shop, I was on a ten thousand pounds a year and it was a big, new shop and I was the youngest manager.
"By the time I was about 30, I earned around £30,000 a year and by 50, I was earning £50,000 a year because it was incremental wage rises, sometimes a few promotions.
“I relocated four times in my career which made a big difference, because if you're willing to move between counties or regions then that was an earning opportunity.
"And that's why I could earn fifty grand a year in the last few years as opposed to collecting thirteen pounds ninety-five in the first month.”
Engage with your savings and watch them grow
In his forties, when he started earning more money, Darren began putting more and more cash towards his retirement.
In part, this was a result of his final-salary pension closing, which led to him becoming far more aware about his pensions.
Another factor was retirement fast approaching and Darren realising that the more he could save, the better his retirement would be.
One tip Darren has for people starting out is to take advantage of modern pensions systems and technology platforms which allow you to log in regularly and see your money grow.
For instance, Darren has consolidated some of his funds with PensionBee, a financial company that allows you to gather your money into one place.
He says: “In the last 10 years, my pension was swapped to defined contribution and that meant I could see how much was going in on my payslip.
"As technology improved it was easier to see things online, particularly in terms looking at the bottom line and thinking about your targets.
“It became more interesting because you could see what you put in and then you could go and look at your investment returns.
"PensionBee as a platform has been really good, I would recommend it to anybody who's thinking about pensions or starting out.”
One note of caution is that pensions investments do go up and down depending on what happens in markets.
However, because retirement funds are long-term investments, the important thing is not to panic when markets fall and to sit tight until your money recovers.
Darren says: “[During the pandemic] my pension fell by 10% and when you see it go down like that you start thinking about what’s next.
"In March and April, we’d lost a lot, but over the next nine months we’d made it back and more.
"That big drop turned into big gain because obviously the people that work in finance know it's actually the best time to buy – while its cheap.
“You sit on it, and the returns will come back. It might take eighteen months or two years, but it will come back eventually when people get the confidence about the market.
"When I spoke to my financial adviser back in January, I said it was a good year last year with gains of around 10%.
"And he said that they think there's another 10% to come this year."
Questions to ask before transferring your pension
IF you’re thinking about transferring your pension, here are the key questions to ask, according to the Money Advice Service.
Questions to ask your current provider:
- Can I transfer? There can be restrictions on which pensions you can transfer.
- What is the ‘transfer value’ of my pension? If it’s the same as your pot value, it’s unlikely you’ll be charged a fee when you transfer.
- What fees will I have to pay?
- Will I lose the right to take out my money at a certain age? This is called a ‘protected pension age’.
- Will I lose any special features, e.g. a guaranteed annuity rate?
- Will I lose the right to take a tax-free lump sum of more than 25% of my pension? This is called a ‘protected tax-free sum’.
Questions to ask your new provider:
- Do I apply to transfer through you or my current provider?
- Are there any fees for transferring in, e.g. set-up fees?
- Do I have to make regular payments into the new pension?
- What investment funds and levels of risk do you offer? You may need help from a financial adviser with this.
- What options do you have for when I want to take my money out?
Boost your pot
In the run up to retirement, Darren says the most important thing he did was to start ramping up his contributions.
In part, this was to boost his pension fund, but he also says that reducing his tax payments was a big motivation.
He says: “In the last ten years, I was putting enormous amount.
"As you become aware, you're thinking the taxman could have a bit less and actually it was the tax I was saving by point that motivated me the most.
"I didn’t want to pay 40%, but by contributing more through salary sacrifice, I could move down a tax band.”
Darren also started to build a budget to see where he could cut back on his expenditure and how much he would need when he retires.
He sat down with his partner to set some goals and do the sums around incomings and outgoings – looking at everything from phone costs and TV packages, to WiFi and car outgoings.
He says: “I used to be pretty lethargic about budgeting, but in the last ten years as I could start to see the finish it became a priority and I could see how important it was to maximise my savings."
The different options available in retirement
WORKING out what to do with your pension is one of the biggest decisions you’ll ever make.
New freedoms introduced in 2015 mean that you have more options than ever before.
Broadly, you can do one of a handful of things with your money:
- Annuities – you can buy an annuity which gives you a guaranteed income for life. The main benefit is knowing you'll never run out of money, but lots of people consider annuities to be poor value, and you won't benefit from investment growth either. Make sure you shop around if you buy an annuity.
- Drawdown – These days, many retirees opt to leave their pension invested in the stock market, and take income as and when they need it, via ‘drawdown.’ You'll benefit from flexibility about how and when you take your money, but will also face stock market risks. It's worth seeing an IFA if you choose this route.
- Cash lump sums – Some schemes offer uncrystallised funds pension lump sums (UFPLUS) which is a way of taking regular cash out your scheme without buying a drawdown or annuity product. However, many pensions don't offer this. There may also be limits on what you can take each year.
- Cash it all – You could decide to withdraw all your pension at once, but this is not advised unless you have a very small pot. Because pensions are taxed as income, you could end up paying 45% to the government if you take it all in one year, whereas you can reduced your tax bill substantially by spreading payments out.
- Mix up the options – You can can choose a variety of options, for instance drawdown in early retirement and an annuity for peace of mind in later life. You may also want to think about other savings such as ISAs which you can draw tax free.
Speaking to an IFA is the best way to plan your retirement and make sure your money lasts and you're being tax-efficient.
Making the money last
Although Darren is semi-retired, he still wants to make sure that his money lasts as long as possible.
At the moment, he is drawing small amounts from his PensionBee pension, whilst avoiding the money he built up in his final salary pot.
Usually, the defined benefit, final salary scheme pays out a guaranteed income for life, but after a period of ill-health, Darren transferred it into a defined contribution scheme, which he can access when wants.
Thanks to lockdown Darren has kept most of his retirement fund intact and growing strong.
Once restrictions ease, he plans to draw more of his money and has several cruises planned with his partner.
He is being cautious with his spending though as he doesn’t want to pay more tax than necessary and is keen to make sure his money lasts for the whole of his retirement.
Staying tax efficient
Keeping his tax bill low is a top priority for Darren, so he is planing carefully to make sure that that what he withdraws will not push him into the 40% tax bracket.
To achieve this, he has several pots that he can access at different times, and he also works with a financial adviser.
He says: “The less tax I give back, the better, so I will do my best for the next few years at least, to say stay under the tax code and the good thing is that PensionBee produce a little payslip that both the Inland Revenue and you can see every month which shows what you took. The clarity is amazing.”
How to get help or advice when you’re approaching retirement
DECIDING how to take your money when you retire is complicated and getting it wrong can leave you with a hefty tax bill, not to mention the risks of running out of funds too early.
When you take out a private pension, 25% of your savings is tax-free and the remaining 75% is taxed at your marginal rate.
There may also be charges for cashing in your whole fund, and not all pension schemes will offer this option.
Tax charges applies if you take out your money in stages too.
The government-backed Pension Wise service offers free one-to-one guidance at pensionwise.gov.uk/en.
You make also want to take bespoke advice to make sure you're not paying more tax than you need to.
You can use the The Money Advice Service Retirement adviser directory, Unbiased or VouchedFor to find one near you.
Check your state pension
Darren’s final tip is that people should check their national insurance record to make sure that they are on track to get the full amount.
You can view your own record on gov.uk.
He says: “Make sure you check your national insurance contributions as that could be a lifeboat for savers. While it’s great to have the extra savings don’t forget the basics.
"Check that, be aware of that, then build on it. Regularly looks at all your benefits and pensions statements, if you keep checking you’re more likely to engage and pay more.”
How saving £100 a month in your 20s will give you a pensions pot worth £321,800 to retire on.
How switching from your workplace pension could cost you £247,000.
If you want holidays when you retire you’ll need a £305k pension pot.
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