“Before you can become a millionaire, you must learn to think like one. You must learn how to motivate yourself to counter fear with courage.” — Thomas J. Stanley
Fancy making an easy million pounds? If so, keep reading. Actually the amount is just more than a million, it’s £1,055,000.
Hold on: £1,055,000? Haven’t we seen that figure before somewhere in this blog? Correct. On this article all about pensions. That’s right, you can make £1,055,000 via your pension… easily.
The £1,055,000 is the maximum lifetime allowance that you can have in your pension before you start getting charged additional tax on withdrawing the pension.
You might be thinking, £1,055,000! That’s insane. I’ll never earn that sort of money in my life. And I say, really? Are you sure? If you earn the UK national average wage of £28,000 at aged 20 and continue to earn that without ever getting an increase to age 65, then you would have earned £1,260,000. So already you’ve earned more that the lifetime allowance of a pension. You would actually have to cut back the closer you come to retirement to avoid the additional tax.
But, you say, I need to live off that £28,000. I can’t just put it all in a pension. And you’re right. But, to have £1,055,000 you don’t need to put all your salary into a pension.
Let’s quickly look at the nuts and bolts of a pension, specifically a workplace pension.
- You contribute a percentage of your salary each month, minimum 5%.
- Your employer contributes a percentage each month, minimum 3%.
- The government contributes tax relief of either 20% for basic tax payers and 40% for higher tax payer.
- All of the above goes into a pension fund, which is the stock market, and grows over the years until you reach retirement.
- When you decide to retire you can take 25% of your pension, tax free! Tax free everyone! The two loveliest words.
- The remaining 75% you can withdraw just like taking a salary and get taxed at the same rate.
- Die before 75? Great news, it all goes to your spouse tax free!
That’s it, simply put. You’ll have £1,055,000 in your pension when you retire. You’ll potentially take 25% of £1,055,000, which is £263,750, tax free. Over half a million big ones, tax free! Then with the remaining £791,250 you will leave that in your pension, so that it continues building money, and you just take out what you like each week/month and enjoy retirement.
But, you say, how do we actually get to the £1,055,000? It all sounds good, but I’ll never accumulate that amount.
Let’s see how by using the 20 year old earning £28,000. For simplistic sake, let’s pretend the 20 year old begins work on 1st January 2020, and will retire 1st January 2065.
The 20 year old will have 540 pay days in that time period of 45 years.
The 20 year old is auto enrolled into their workplace pension and decides to contribute a little more than the standard 5%. They go with 7%. This difference is not noticeable in their monthly salary.
Using the calculator from the amazing website The Money Advice Service we can do some predictions. With the 20 year old making a 7% contribution, and their employer making a minimum 3% contribution, and the government providing a 20% tax relief, the full amount going into the pension every month is £233.33.
The next thing the 20 year old does is move their pension from the default bitch fund their employer put them into, and find an index fund with lower costs, as the lower the cost of the fund the more money the 20 year old keeps; then they find a fund that is more aggressive than the default one, they find the fund that is 100% stocks, as they have lots of time for temporary dips in the market. The more aggressive the risk rating on the index fund, the higher the potential return.
Let’s say they’re in a fund that is 100% stocks, which provides, on average, an 8% return each year. Some years it will be lower than that, and some years higher, but it averages out at 8%.
Now, let’s use the amazing investment calculator from calculator.net and in the field “Starting Amount” we’ll add 0. Then in the “After” field we’ll add 45 years as that’s how long they will be contributing. In “Return Rate” we’ll add 8 to indicate the pension pot will be growing at 8% on average each year, and finally in “Additional Contribution” we’ll add £233,33 as that’s the amount we’ll be contributing each month. We then click “Calculate”.
Hmm. In the “Figure End Balance” we get £1,121,329.61. That can’t be right. For the next ten minutes we keep shutting down the browser and trying this again, yet we keep getting the same figure.
Yes! It’s correct. Way over a million pounds! All for the sake of adding £233,33, which, might I add, didn’t all come out of the 20 year old’s salary.
£70 of that came from their employer.
So that’s only actually £163.33 from the 20 year old.
And of that £163,33, there is tax relief of £32.67.
So that’s actually only £130.66.
Let’s divide that by 4 to get the weekly total and that’s only £32..66 a week.
Or £4.66 a day!
Plus there’s more that 28 days in a month, so it’s even less.
For less that £4.66 a day you can be a pension millionaire.
The amount above is above the £1,055,000 lifetime allowance, so they would be getting taxed more. But, three things can happen:
- The government will increase the lifetime allowance along with inflation, so in 40 years the lifetime allowance should be higher.
- As they get closer to retirement age they will want to move out of the aggressive fund and into a bitch fund, so if there’s a temporary dip in the stock market they won’t be hit so hard.
- The amounts might differ and all figures are only a projection for demonstration purposes, so the total figure might be higher or lower.
Okay, you say. Sounds marvellous. Now let me jump in my time machine, go back ten, twenty, thirty years and tell my twenty year old self to start saving into my pension. I’m forty now. What am I supposed to do?
You do the same above, but you contribute much more. We calculated 7% in the example, you have to contribute more. You have to go aggressive with your contributions. Your money needs to do the hard work, compared to the twenty year old, where time does the work.
If you’re on the same £28,000 salary and you’re 30 years old, you need to contribute 18% rather the 7%. Sounds a lot 18%, but let’s do the sums.
Full contribution to your pension would be £490.
But remember your employer pays £70 of that, so it leaves £420.
Of that £420, the government give you £84 in tax relief.
So £336 comes from you. Not as heave as the original £490.
That’s £84 a week,
Or £12 a day. Plus there’s more that 28 days in a month, so it’s even less. Some people spend £12 a day on lunch. Bring lunch if from home and that saving will make you a millionaire.
But don’t feel duped. Unlike the twenty year old, they’re a good chance you’ve purchased your property, so don’t have to worry about that. Also there’s a good chance you’re earning more than £28,000, so even if you did 7% your contributions, and your employer’s will be more than £233,33.
If you contribute, 10% or 15% or 20% or 50% then you’ll be pumping money into your pension, the government will be giving tax relief and the stock market will be churning your money into, hopefully, a nice million quid!
To wrap up, if you’re not in your pension, get in it today. Use the two calculators that are linked in this article to work out how much you need to contribute. And if you can, keep increasing the contributes, every three to six months, and especially when you get a pay rise or bonus.
Good luck and I’ll meet you in the millionaires’ club when we retire.