Pension investing: when should you stop?

Saving enough to fund your retirement is the primary goal for most investors. But the UK government has imposed an onerous 55% tax charge for pension pots breaching a £1 million lifetime allowance. How much should you have saved, and at what age, to get there?

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Pension investing

Over the past few years, UK government policy has encouraged investors to put money into ISAs (current annual limit £20,000) where tax is taken up front, rather than into pensions, where tax is taken many years later when money is withdrawn.

The majority of pension investors are unaffected by changes to government policy, but higher earners should take into consideration a series of measures designed to reduce the attractiveness of pensions as a long-term tax shelter for the better off. In recent years the Government has:

  • Trimmed the pension lifetime allowance to £1 million, after which a 55% charge is levied on lump sums
  • Reduced the annual amount that can be saved to £40,000 a year
  • Introducing a tiered system for higher earners, that limits the amount saved to £10,000 for those earning over £210,000

We would be surprised if the tinkering ends there; MPs from both sides of the political spectrum have suggested that the existing 40% tax relief for higher earners (which ‘costs’ the treasury more than £30 billion a year) should be reduced to a uniform flat rate for all tax payers. In effect, this would mean there would be no escape from some up-front taxation. 

Saving as much as possible into a pension should be a priority – but how much?

With pension contribution limits and tax relief likely to be squeezed further, it is crucial for higher earners to have a good idea of how much they need to invest to keep themselves within the lifetime allowance of £1 million, a sum which HM Revenue and Customs (HMRC) will increase annually in line with the Consumer Price Index (CPI) inflation figure.

Knowing when to stop investing in your pension, and when to fund alternative tax structures (such as the Lifetime ISA which offers a £1,000 ‘bonus’ on savings of £4,000), now constitutes an important part of your retirement planning.

To assist investors, we have produced tables to illustrate what value should be held in a pension, at what age, to reduce the need to ever contribute to a pension again.

Over the past 100 years, the Barclays Equity Gilt Study demonstrates that investors in UK equities would have made an average real return of 5.0%. It is worth noting that this is calculated over the Retail Price Index (RPI), which has increased over the past 20 years by 2.8% a year; 0.8% a year more than the CPI figure used to increase the pension lifetime allowance. Consequently, we use 6% as our upper real return boundary in the tables. If your investments rose in value at a faster rate, you could retire earlier or save less. 

IG pension tables

Table 1: amount required (£) to retired aged 55

Real return

2.0%

3.0%

4.0%

5.0%

6.0%

20 500,028 355,383 253,415 181,290 130,105
25 552,071 411,987 308,319 231,377 174,110
30 609,531 477,606 375,117 295,303 232,999
35 682,971 553,676 456,387 376,889 311,805
40 743,015 641,862 555,265 481,017 417,265
45 820,348 744,094 675,564 613,913 558,395
50 905,731 862,609 821,927 783,526 747,258
55 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000

 

Table 2: amount required (£) to retired aged 60

Real return

2.0%

3.0%

4.0%

5.0%

6.0%

20 452,890 306,557 208,289 142,046 97,222
25 500,028 355,383 253,415 181,290 130,105
30 552,071 411,987 308,319 231,377 174,110
35 609,531 477,606 375,117 295,303 232,999
40 672,971 553,676 456,387 376,889 311,805
45 743,015 641,862 555,265 481,017 417,265
50 820,348 744,094 675,564 613,913 558,395
55 905,731 862,609 821,927 783,526 747,258
60 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000

 

Table 3: amount required (£) to retired aged 65

Real return

2.0%

3.0%

4.0%

5.0%

6.0%

20 410,197 264,439 171,198 111,297 72,650
25 452,890 306,557 208,289 142,046 97,222
30 500,028 355,383 253,415 181,290 130,105
35 552,071 411,987 308,319 231,377 174,110
40 609,531 477,606 375,117 295,303 232,999
45 672,971 553,676 456,387 376,889 311,805
50 743,015 641,862 555,265 481,017 417,265
55 820,348 744,094 675,564 613,913 558,395
60 905,731 862,609 821,927 783,526 747,258
65 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000

 

Table 4: amount required (£) to retired aged 70

Real return

2.0%

3.0%

4.0%

5.0%

6.0%

20 371,528 228,107 140,713 87,204 54,288
25 410,197 264,439 171,198 111,297 72,650
30 452,890 306,557 208,289 142,046 97,222
35 500,028 355,383 253,415 181,290 130,105
40 552,071 411,987 308,319 231,377 174,110
45 609,531 477,606 375,117 295,303 232,999
50 672,971 553,676 456,387 376,889 311,805
55 743,015 641,862 555,265 481,017 417,265
60 820,348 744,094 675,564 613,913 558,395
65 905,731 862,609 821,927 783,526 747,258
70 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000

 

Understanding the tables

The data is shown in ‘real’ terms, meaning that the impact of inflation is taken into account. For example, if the total return of your pension is 7% next year, but CPI inflation is 2%, the ‘real’ inflation adjusted return would be 5%.

Most investors (especially those looking at annuities) would probably want to de-risk their investments before retirement, though many wealthier savers may take the view that they can largely live off equity income alone. For those wanting to de-risk, they should choose an age and then move to the left of the table to select a lower return profile.  For example, a 55 year old looking to take their pension at 65 would need £820,348 if they grew their investments at a 2% real return, or £675,564 if they grew them at 4% real return.

The tables show that starting early and investing in investments with a higher return can make a huge impact on the age you can stop adding to your pension.

In this instance, a 40 year old looking to retire at 65 with a £1 million pension pot could stop making contributions when their pot reached £232,999 at a 6% real return, but that would rise to £477,606 if their investments grew at a 3% real return.

What if you’re nowhere near the lifetime allowance?

 It is true that being able to stop putting money into your pension is a luxury that relatively few people can aspire to, but while most people’s goals will be more modest than £1 million, every investor can benefit from these rules:

  1. Start saving as early as you can. The effects of long-term compounding of returns should not be underestimated
  2. If you have one, take advantage of your company scheme. If your employer will match your contributions, make sure you do that
  3. Costs matter, more than you might think. Small changes in your annual growth rate can make a huge difference to your final pension. Read more about how fees and inflation are eroding your savings

Find out how an IG Smart Portfolio could help you reach your investment goals. Try our pension calculators or learn more about our self-invested pension plans (SIPP).

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