What will a million-pound pension get me?

A £1 million pension pot is an admirable goal. It sounds like – and is – a lot of money, but is it enough to give you the pension income you dream of?

A £1m pension can provide substantial retirement income. However, whether it provides the income you desire depends on many variables, such as your age at retirement, investment returns and whether you choose a drawdown or an annuity.

This article looks at how much pension income a £1 million pension pot could produce and how it is impacted by the age at which you retire. We will explore the two main ways of taking your pension benefits; Flexi Access Drawdown and an annuity.

Heritage Financial Planning can provide expert advice on pensions and investments to help plan for a rewarding retirement. To speak to one of our financial advisers, please get in touch.

What income will a £1million pound pension produce with pension drawdown?

Flexi Access Drawdown allows you to take a tax-efficient, flexible income from your pension savings. You can take as much or as little as you like and shape the income around your individual circumstances and the different stages of retirement.

This flexibility enables you to take a higher income during the active years of your retirement or before your state pension and/or final salary pension kicks in.

You can also choose to draw only the tax-free portion of your savings to pay for a holiday or to reduce your mortgage, for example.

Usually, the remaining pension pot is invested and hopefully leads to investment growth over the life of the pension. This growth can help offset any withdrawals to ensure the pension pot lasts for the duration of your retirement.

Put simply, if the annual pension drawdown amount is 4% of your pension each year and it grows by 4% a year, then in theory, it shouldn’t go down. In practice, it is not so black and white, and it depends on the timing of your withdrawals. But the example gives you an understanding of how investment earnings can help top up your pension pot.

Example: How much income a million-pound pension pot can generate with drawdown

It is hard to say exactly how much income you can take from £1 million pension savings if you go down the drawdown route, as that is entirely up to you.

But to give you an idea of how much income you can take and how that affects the sustainability of your pension, we provide an example based on the following:

• Gareth retires at either age 55, 60 or 65.  
• Gareth’s life expectancy is age 90, and the drawdown fund will be extinguished at this age.  
• We will assume his investment returns are 4%, and this is net of all fees.  
• The income taken from the outset increases by inflation so that it maintains its purchasing power. For inflation, we will assume 3% a year. 

Gareth retires at aged 55:

If Gareth retires at age 55, his retirement period is potentially 35 years.

Based on the assumptions above, a £1m pension could provide Gareth with a starting pension income of £34,092 per year, which increases with inflation.

By age 74, the pension fund would still be worth over £845,000.

If Gareth were to die prematurely, his beneficiaries could potentially inherit the remaining pension pot tax-free.

Once Gareth reaches state pension age, assuming he receives the full state pension (£10,600 in today’s money), at age 68, he would have a retirement income in excess of £40,000, giving him an extremely comfortable retirement.  

Gareth retires aged 60   

If Gareth retires at age 60 with a million-pound pension pot, the retirement term would be shorter at 30 years. So there is less strain on the pension, which allows him to take a higher annual income.  

If Gareth opts for an annual income of £39,046 per year, by age 74, his pension savings would still be worth over £835,000.

Along with his state pension (assuming he receives the full amount), this could potentially lead to an annual income of £49,646 in today’s money.

Gareth retires aged 65

Finally, if Gareth retires and starts drawing down from his £1million pension pot at age 65, the retirement term is just 25 years.

If he takes a starting income of £46,147 that increases with inflation, by age 74, the pension pot would still be worth over £851,000.

Gareth’s lucky beneficiaries could inherit that amount tax-free.   

Along with the state pension, his annual income would be in excess of £58,800.

In summary, the following table shows the potential income available from a £1m pension using draw down from ages 55, 60 and 65:

The difference your retirement age makes to your annual income is significant. While Gareth may be completely satisfied with the lowest of these starting incomes, if he has his sights set on £40k+, he will either have to save more or retire later.  

The 4% rule of thumb

The 4% rule originated from a US study in 1994 which found that if you withdrew 4% of your investment portfolio each year over a retirement of 30 years or less, then historically, at least, you wouldn’t exhaust your funds if you were invested in a balanced portfolio made up of 60% stocks and 40% bonds.

It’s often referred to as a Sustainable Withdrawal Rate (SWR). It’s been argued that 4% as a SWR is too high and that a more realistic SWR is closer to 3%. Others would say that 4% is too low and that a 5% Sustainable Withdrawal Rate is more sufficient.

Here you can see how different SWR affects the amount of drawdown income available from a £1m pension:

• 3%  – £30,000  
• 4%  – £40,000  
• 5% – £50,000

You shouldn’t use a Sustainable Withdrawal Rate blindly as it doesn’t take into account the amount of time you will be in retirement, one-off costs or the potential of poor investment returns. However, it’s a useful tool to provide an approximate idea of pension income.

What are the risks of drawdown?

The flexibility and tax efficiency of drawdown are perhaps the greatest benefits, but, as with all investments, there are disadvantages.

So it’s wise to look at how drawdown can go wrong:

• When you withdraw from your pension pot, the remaining funds are invested – but this can be a double-edged sword. If returns are lower than expected, you may have to reduce your annual drawdown, or your savings will start to deplete.
• If you take too much from your pension, the withdrawals may not be sustainable over the longer term. Data from the Financial Conduct Authority in 2021 found that the average retiree in drawdown is taking 8% of their pension a year. This is considerably more than what is considered a Sustainable Withdrawal Rate, which is in the region of 3-5%.
• If your life expectancy is longer than expected, then this will place a strain on your pension fund. As we saw in Gareth’s example above, the longer your retirement, the less income you need to take to make it sustainable.

An example of how drawdown can go wrong:

• Gareth retires at age 60
• His net investment returns are worse than expected at 2% a year 
• He withdraws 7% of his pension pot each year, which equates to an annual starting income of £70,000 a year.  

In this scenario, Gareth’s pension would run out at age 74, leaving him facing financial uncertainty in his remaining years.

What income will a £1million pound pension produce with an annuity?

Note we will focus here on lifetime annuities.

When you opt for an annuity, you essentially swap your retirement savings in return for a guaranteed income that is paid for life. Once you die, the annuity usually dies with you. It is possible to add inflation protection to maintain its purchasing power and also a survivor’s pension to provide for your loved ones, but this usually reduces the starting income.  

As the income is guaranteed, there is no risk of running out of money as the annuity income is usually paid for life. This is beneficial to those who are uncomfortable with investment risk.   

Annuities fell out of favour after pension freedoms were introduced and because of the ultra-low interest environment that existed up until 2021.

You can see how the potential income from annuities has increased dramatically as interest rates have risen in recent years to combat inflation:

What impacts the retirement income available from an annuity?

How much retirement income you can achieve from an annuity depends on many factors, such as:

• Your age at retirement. The older you are, the better the rate tends to be, as statistically, your insurance company will be paying out for a shorter period of time.  
• Your health. If you have any health conditions, you may be entitled to an impaired annuity which can lead to a higher annuity rate.
• Inflation and/or survivor’s pension. If you add these benefits, it usually reduces starting income.
• Annuity rates. These vary between different insurance companies and can change.

What retirement income can I get from an annuity with a £1m pension pot?

Once again, there are variables at play. It depends on which options you choose from the outset. To illustrate how these options affect retirement income, here are two examples, both of which assume the person is in good health.

Annuity 1 – Single Life annuity with inflation protection 

Annuity 2 –  Based on an annuity with a 50% survivor pension, increases with inflation and has a 5-year guarantee  

As with the drawdown example, here are some examples of an annuity purchased at ages 55, 60 and 65 to show how retirement age affects starting income.

Age 55*:

Age 60*:

Age 65*:

*Note that annuity rates change all the time, as we can see in the graph above.

What are the risks of an annuity?

The absence of risk is, of course, an annuity’s main selling point. But that’s not to say it doesn’t have its disadvantages:

• No flexibility. Once the annuity is set up, you can’t usually change it. Many retirees prefer to take more money during the active years of their retirement, which you cannot do with an annuity.
• Poorer death benefits. An annuity will usually die with you, assuming you haven’t built in any guarantees or a survivor pension. If you do opt for an annuity with these protections, it will reduce your annual income

How much income tax do you pay on pensions?

While your pension contributions are subject to tax relief up to your lifetime allowance, your pension income will be subject to income tax. The tax treatment depends on the option you choose.

With a lifetime annuity, your regular income will be taxed at your marginal rate.

With drawdown, you can usually take 25% of the uncrystallised pension as a tax-free lump sum. The remaining crystallised funds are then classed as taxable and subject to income tax at your marginal rate. So how you structure your drawdown income and any other pension income you may have is very important.

Read more about how to take your pension income tax efficiently.

Get pension advice from Heritage Financial Planning

Pension and retirement planning is complex, so the help of an experienced financial adviser can be very valuable. Whether you are looking to retire soon or are just starting to save, the experts at Heritage Financial Planning can help you with pension planning to achieve your goals.

Contact us today to get started.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. The Financial Conduct Authority does not regulate tax planning. Past performance is not a reliable indicator of future performance and should not be relied upon. Annuity rates may change in the future, which could reduce the potential income.