Why you need a £1 million pension for a comfortable retirement

Retirement may not be front-of-mind for most young people but new research suggests they need to build a pension pot worth almost £1.1 million to fund their golden years.

The cost of retirement is rising and the latest figures from the Pensions and Lifetime Savings Association (PLSA) suggest a pension pot worth between £490,000 to £790,000 is needed to purchase an annuity that would cover the costs of a ‘comfortable retirement’ alongside the state pension.

But interactive investor highlights that these figures don’t take inflation or housing costs into account.

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In fact, the investment platform suggests a worker in their 20s would actually need around  £1,081,939 in their pension to achieve a comfortable retirement, assuming 2% inflation. This assumes an annuity rate worth £8,000 per £100,000.

Many young people could therefore face a shortfall if they don’t contribute enough into their pension or don’t have other sources of retirement income.

The cost of a 'comfortable' retirement

The latest figures from the PLSA suggests a single retiree would need an income worth £43,100 for a comfortable retirement.

This would help cover the costs of spending around £130 per week on groceries and £80 a week per couple on meals as well as extra luxuries such as regular beauty treatments, theatre trips and a two-week holiday in Europe a year. 

The PLSA estimates that an individual would need a pension pot worth between £490,000 to £790,000 to generate an annual income of £43,100 from an annuity.

But once you take future housing costs and inflation of 2% into account, the figure actually reaches £1.1 million, according to interactive investor.

That creates a challenge for most younger workers, especially as they may have other expenses such as childcare or saving to get on the property ladder.

If you earned the median-full time salary of £35,000 at age 20 and contributed 8% into your pension over 40 years, your pension pot would be worth £460,664.

This assumes 5% investment growth after fees and 2% pay growth and inflation.

Increase your pension contributions to 10% and your pot could be worth £577,333 after 40 years or £691,977 based on putting in 12%.

Even at these contribution rates, the pot falls short of the £1 million needed and is below the current PLSA maximum suggestion of £790,000.

It may still be achievable to at least reach a minimum or moderate level of retirement with larger contributions, the research shows.

Interactive investor estimates that individuals would need a pension pot worth £88,322 in 40 years to afford a minimum level of retirement or income of £14,400 per year from an annuity or £662,412 for a moderate retirement at £31,300 per year.

“Our calculations shine a light on the punishing impact of inflation over time as the amount needed for a comfortable retirement is expected to double over the next 40 years," says Alice Guy, head of pensions and savings at interactive investor.

"Inflation makes it much harder to achieve your retirement goals, eroding the value of your savings and income in real terms over time."

How to build a £1 million retirement pot

Saving into a pension is one of the best ways to build long term wealth because investments tend to outstrip inflation over time, says Guy.

But if you’re planning to retire before the state pension age you may also need to save more because you’ll have a gap to bridge before the state pension kicks in.

Surpassing the £1 million mark won’t be possible for many pension savers, even with the £60,000 annual allowance, says Joe Fisher, financial planning manager at Lumin Wealth.

But he suggests combining pensions and ISAs, plus the effect of compounding could get people closer to the £1 million target.

“In reality, very few savers in their 20s and 30s will have the annual income to max out these allowances in each tax year, but lump sums  such as from an annual bonus, property sale, parental gift, or an inheritance – could be put towards a pension or ISA, to give your retirement pot a valuable leg up,” he says.

“‘Carrying forward’ any unused pension annual allowances from the three previous tax years could allow you to pay a larger lump sum into your pension and benefit from tax relief on this contribution.”