How much retirement income would you get from a £250,000 pension pot?

The high cost of living in retirement means it is more important than ever to build up a large pension pot.

It is hard to predict what your pension pot will be worth in the future after decades of saving for retirement, but knowing how much income you can generate from a certain amount can help plan and set a target for your golden years.

“One of the big questions when considering retirement planning is how much you are likely to need,” says James Corcoran, chartered financial planner at Lumin Wealth. “None of us have a crystal ball and there are some big unknown factors, such as how long you are going to live, whether you may need long-term care, and what type of support you may wish to provide to family members. 

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

“However, with financial planning what we will typically do is look at various scenarios to see whether people are on the right track for the retirement they want, and then see how we can help them achieve that. Cashflow forecasting can be a very helpful tool here.”

Here is how much retirement income you could generate from a £250,000 pension pot based on the latest annuity rates and drawdown strategies.

What income can you get from a £250,000 pension?

There are a couple of different ways to access your pension fund when you retire.

You could secure a fixed income for life through an annuity or stay invested and make regular withdrawals through pension drawdown.

“Annuities offer simplicity and a fixed income but lack flexibility,” says David Gibb, chartered financial planner at Quilter Cheviot.

“In contrast, drawdown provides complexity and flexibility, with a quarter of the withdrawal being tax-free and the remainder taxable.”

However, he warns that those who opt for drawdown and take taxable income are limited to a £4,000 annual pension contribution under the Money Purchase Annual Allowance if they ever wish to recontinue paying into their pension.

Meanwhile, once you take an annuity, you can’t get that money back.

So it is important to be sure that you are ready to retire before you raid your pension pot.

The annuity option

Annuity rates have hit record highs in recent months off the back of interest rate rises.

Your pension pot is used to purchase an annuity that generates a fixed income paid to you for life, linked to your age, health and where you live.

The income you generate from a £250,000 pension pot will depend on the rates available at the time as well as your own lifestyle.

Analysis by Quilter Cheviot for MoneyWeek shows that a pension pot of £250,000 could provide a 65-year-old in good health with an annual income of £16,258 based on typical rates of 6.5%.

For smokers, these amounts could increase by approximately £600 due to the associated risks and those with other health issues might see an increase of about £1,000 annually, according to Quilter Cheviot.

It may be worth waiting though as the older you are, the more you could get from annuities.

For a 75-year-old, a level annuity could yield £20,227 per year, Quilter Cheviot said.

You can also access 25% of your pension pot tax-free and there may be income tax owed on the annuity payments depending on your total earnings.

The drawdown route

Annuities may provide certainty but unless you have inflation-linked payments, you can’t increase the payments if your needs change.

An alternative is drawdown, where you keep your pension pot invested and either make regular withdrawals that can change as your expenses do or just access the money when you need it.

The main risk is that your pension pot could get depleted and run out if not managed property, leaving you with a poor income in retirement.

Ed Monk, associate director at Fidelity International, suggests following the “4% rule” for withdrawals.

This suggests taking 4% out of the pot each year while the rest remains invested, hopefully meaning it won’t run out.

After taking tax-free cash of £62,500, you could withdraw income of £7,500 per year based on the 4% rule or £9,375 if you went to 5%.

There will be income tax to pay if your withdrawals, along with other earnings, push you into the basic or higher rate tax brackets.

While £7,500 in drawdown is lower than the annuity rate, Monk highlights that the pension money remains yours and is available to use as you wish, including as inheritance to pass on after you die.

“Money used to buy an annuity is no longer yours, although some products will guarantee benefits are paid to loved ones after you die,” adds Monk.

“You don’t have to pick just one method of accessing your pension cash - these options can be blended and changed over time to maximise your income tax efficiently."

How to build a £250,000 pension pot

The time it takes to generate a £250,000 pension pot will depend on when you start and when you plan to retire.

If you invested £250 per month for 33 years, assuming a growth rate of 5% per year, you would build up a pot worth approximately £250,000.

But you would need around £520 per month if you only had 25 years.

Gibb adds that due to inflation, the future value of £250,000 will be less so to save an equivalent amount in today’s terms, a monthly saving of £880 is necessary.

People often underestimate how much money they need to put aside to be able to enjoy a comfortable retirement, warns Joshua Gerstler, chartered financial planner at The Orchard Practice.

“Most couples will now enjoy a three decade retirement so £250,000 is not going to last very long,” he says.

“Nowadays, most financial advisers will create a bespoke lifetime cashflow for you to work out how much you are going to need in retirement and how much you should invest to be able to achieve this.”

Corcoran adds that the state pension will provide a financial boost in retirement, worth £11,502 this year, while retirees may have other sources of income such as a buy-to-let portfolio.

“The pathway to retirement is no longer typical,” he says.

“It is rare that someone works up to state pension age and then just retires.

“Many people will have a mix of different careers and income streams.”