“How much is enough?” is a question often asked about pensions and retirement savings. In this case, “How much is too much?” might be more appropriate.
This week, a freedom of information (FOI) request revealed some eye-opening facts about the UK’s biggest pension savers — including one who has amassed a retirement fund worth £11mn.
The identity of this person and how they built up such a colossal pension is unknown. However, they are not alone in having a supersized fund.
Estimates of private pension wealth compiled by the Office for National Statistics suggest that some 929,000 savers are sitting on a pot worth between £1mn-£2mn. A further 128,000 people have pension savings worth £2mn-£3mn and an estimated 46,000 investors have more than £3mn.
The recent scrapping of the lifetime allowance tax charge on pensions has given Britain’s richest pension investors cause to celebrate — yet with a general election looming, they will be worried about future tax changes.
How could an individual end up with a pension pot worth £11mn?
Rob Burgeman, the investment manager at wealth manager RBC Brewin Dolphin who submitted the FOI request, has a few theories.
He thinks it highly unlikely that someone could have “traded their way to a £11mn pot”, since the huge level of contributions that would be needed to generate a pot of this size mean this person must have been saving into their pension for a long time.
In the past, the annual allowance limiting how much savers could add to their pot was much more generous.
In 2010, for instance, highly paid executives could have squirrelled away up to £255,000 a year and benefited from tax relief. For much of the past decade, however, the maximum has been £40,000 per year, with a pensions taper further reducing contributions for the highest earners.
“Assuming this is a defined contribution [DC] pot, it could also belong to someone who founded a business, and put some shares in their own company into the pension, which has done phenomenally well,” he says.
Clare Moffat, pensions expert at Royal London, speculates that it could be someone with commercial property investments in a Sipp (self-invested personal pension) or a SSAS (small self-administered scheme).
She also suspects others in this group “could be very high earners who were in a defined benefit scheme and carried out a defined benefit [DB] transfer”.
Whoever they are, and however they built their wealth, they are likely to be male. The ONS data shows the top decile of pension wealth is skewed heavily towards men (66 per cent, versus 34 per cent for women) and includes “some very wealthy outliers”.
What kind of retirement could one potentially buy with a pension of that size?
The short answer is, a very comfortable one. People with large pension pots have benefited hugely from the chancellor’s recent removal of the lifetime allowance (LTA). Before April’s rule change, there was a cap of £1.073mn on how much could be saved into a pension over a person’s lifetime, above which punitive tax charges applied.
However, the maximum tax-free lump sum remains capped at 25 per cent of that figure. So unless this person had previously applied for protection from the LTA, the most our £11mn man (or woman) could take tax-free would be £268,275.
Future drawdown by the individual would be subject to income tax at their marginal rate, but this would be a maximum of 45 per cent compared with a 55 per cent tax charge before the LTA was scrapped.
Burgeman calculates someone with an £11mn fund would be able to take an annual income of £540,000 over a 30-year retirement period and never worry about running out of money.
What tax planning issues do people with large pensions need to be aware of?
The Labour party has already vowed to reinstate the LTA, but regardless of who wins the upcoming general election, experts fear future pension reforms are inevitable — not least because of the huge cost of tax relief.
The favourable treatment of pensions under inheritance tax (IHT) rules is a live area of concern. As pensions fall outside one’s estate for IHT purposes, wealth managers often advise their clients to “spend the pension last”. However, the Treasury is consulting on a rule change that would make inheriting DC pensions less advantageous for beneficiaries taking income.
“This would be a major change as currently people can pass their pension benefits to their beneficiaries free of income tax if they die under the age of 75,” says Moffat. “Lump sums would still be free of income tax, but taking them as drawdown wouldn’t be.”
“Post 75, all benefits are subject to income tax at the beneficiary’s marginal rate of tax. But this potential change is not in the draft legislation published, although an HM Revenue & Customs newsletter published soon afterwards states that is part of the consultation. So it’s a wait-and-see approach for this currently.”
Others worry the limits on tax-free lump sums could be reduced in future.
“It’s rare for people with large pensions to take out the maximum lump sum in one go unless they have a mortgage to pay down or want to help their children,” Burgeman says. He says that phased drawdown — where people can access their tax-free cash over many years — is growing in popularity.
“In retirement, flexibility is really important,” he adds. “The only certainty with pensions rules is what you can do today.”
“If a person takes their tax-free cash and leaves it sitting in a bank account, it’s just waiting for IHT at 40 per cent,” adds Moffat, who suggests using up tax-free cash more tax efficiently.
“Gifting it to relatives if the person is in good health, paying family pension contributions or into other tax-efficient savings vehicles work well for family tax planning,” she says. “Paying pension contributions for grandchildren can also be a good idea as the generations of the future will be unlikely to have such large pension pots.”
If £11mn is the largest pension, how does the rest of the UK measure up?
The ONS estimates you need to have pension wealth of £374,500 to be in the top 10 per cent of retirement savers. However, the average (median) size of all pension funds, including those in payment, is a more modest £57,000.
Men have an average of £75,000 and women an average of £43,500.
“Although auto-enrolment has been very successful, most people won’t need to worry about having a large pension fund and instead they will be concerned about having enough money in retirement,” says Moffat, noting that certain groups, especially women and the self-employed, face limitations on their ability to save for retirement.
Even so, if you started pension saving early, the miracle of compound interest would turbo-charge your contributions. RBC Brewin Dolphin calculates an 18-year-old entering the workforce today, who saved £389 per month into their pension could reasonably expect to retire with a £1mn pension pot aged 68, assuming annualised returns of 5 per cent after fees.
This is a high sum for a young worker, Burgeman points out: “This would cost you less than £389 with tax relief at your marginal rate and even less if there are employer contributions as well.”
Claer Barrett will be putting readers’ pension questions to a panel of experts including former pensions minister Sir Steve Webb at the FT Weekend Festival on Saturday September 2. Mark your email “pension question” and send it (in confidence) to money@ft.com
