Making the minimum contributions to a pension through auto-enrolment could build a £1 million pension pot over an individual’s working life, but that milestone figure may still mean many people fall short in retirement, according to Murphy Wealth.
New figures from the wealth manager suggest that on the UK’s median salary over the course of a 45-year career, someone starting today could expect to build up a £1 million pension pot as they approach retirement – reaching the milestone by the 44th year and just over £1.1 million by the time they stop working the following year.
The projections assume the median salary increases at an annual average rate of 3%, broadly in line with long-term averages, and the investments grow at a yearly average of 6%. It also assumes no career breaks or other substantial gaps in contributions.
But, by that point, the value of the pension pot will have been eroded by the rising cost of living. Assuming inflation also averages 3% – it has averaged 3.09% since 1981, according to the Bank of England – the pot’s value in real terms would be the equivalent of around £290,000 today.
Murphy Wealth’s projections suggest the fund could last as little as 11 years with no state pension, or around 19 years with the full amount, based on Pensions UK’s retirement living standards. They also assume the state pension increases at 3% annually (below the 5% average since 2016) and no tax-free lump sum is taken out. Withdrawing the full 25% tax-free lump sum – notwithstanding the current £268,275 limit – would reduce the pot’s longevity to eight years without the state pension, and 13 years with it.
The figures come after the Pension Commission recently warned of the financial cliff edge many face in retirement, with 15 million people currently under-saving for retirement. In its interim report, the Commission said low and middle earners are particularly at risk, with around half saving only at minimum automatic enrolment levels with little else to fall back on.
Increasing auto-enrolment contributions to a minimum of 12% of pay, as some have suggested the Pension Commission may do in its final report, could build up a pot of £1.65 million based on the same assumptions. This would last for 17 years without any state pension, and 12 years withdrawing 25% as a tax-free lump sum during the first 12 months.
Adrian Murphy, CEO of Murphy Wealth, said: “A £1 million pension sounds like it should be enough to cover a comfortable retirement. That figure – often seen as a milestone – might encourage many people to stick with the minimum contributions required by auto-enrolment, rather than choosing to increase the amount they put away each month.
“But that ignores the long-term effect of inflation. The rising cost of living means that every year your money loses purchasing power and, as these projections show, for anyone at the beginning of their pension saving journey, that £1 million could be worth not far off one-quarter of what it is today.
“That has serious consequences for the longevity of your pension in retirement – particularly given we’ve assumed the state pension will rise in line with inflation, which isn’t guaranteed, and you do not withdraw a tax-free lump sum at the beginning. All of these factors could significantly reduce how long your pot will last, particularly if, like many people, you opt to take out as much of your tax-free lump sum as possible.
“Don’t underestimate the effect of inflation on your pension and savings – and don’t rely on minimum requirements set out by the government. There are few hard and fast rules when it comes to preparing financially for retirement, but setting out a plan and putting away as much as you can each month towards your pension is a good starting point.”
