How you can build a £100,000-a-year pension – and how to spend it

The pension industry says you need £37,000 a year in retirement to be “comfortable”. But what if you really want to enjoy the finer things?

For some, a six-figure income in retirement is necessary to cover running costs, have a few decent holidays and be able to splash out from time to time.

So, how large does your pension need to be to generate £100,000-plus a year, and what’s the best way to generate an income?

Start young or be prepared to dig deep

How much you need to save to be able to generate a £100,000 income will depend on investment growth and contributions, as well as how long you plan to draw on your pension – that is, the number of years you’ll be retired. 

Most people retiring in the private sector these days have “defined contribution” pension which are typically put into “income drawdown” accounts. This allows you to take money out of a pension whenever you like while leaving the remainder invested.

Let’s assume you retire at 55 and live until age 85. According to stockbroker Fidelity International you can withdraw between 4pc and 5pc a year and your pot should last for that 30-year period.

Based on projection, a £2m pot could generate up to £100,000 income per year.

In the past a £2m pension would have been hit with large tax charges because it breached the “lifetime allowance” – but Jeremy Hunt, the Chancellor, scrapped the limit at the 2023 Budget.

That means the coast is clear to save as much as you like in a pension. However, there are limits on what you can place in a pension each tax year. The annual allowance is currently £60,000 for most people.

But you are also limited by your earnings – you only receive tax relief on a contribution that is not larger than your income in a given year. And if you’re a high earner with an income above £200,000 a year, your annual allowance might gradually reduce to as low as £10,000. This is known as the “tapered” annual allowance.

The road to £100,000-a-year

Fidelity International’s Ed Monk, said: “The only way to reach such a large income in retirement would be through a combination of heroic levels of saving and a fair wind from investment returns to ensure your pot doesn’t run dry too early.”

According to calculations by Fidelity, a 25-year-old would need a monthly contribution of £1,311 to reach £2,000,600 by age 65. 

Assuming they were starting with nothing saved, a 35-year-old would need to save £2,404 a month into a pension to reach £2m, while a 45-year-old would need more than double at £4,867 a month to hit £2m.

The beauty of saving in a pension is the tax relief on contributions. You get 20pc paid into your pension by HM Revenue & Customs and higher or additional-rate taxpayers claim extra relief via a tax return. If all the reliefs are claimed the effect is a higher-rate, 40pc, payer only needing to pay £60 to make a £100 contribution.

You also get free cash from your employer on top of your own contributions. The minimum total contribution under automatic enrolment is 8pc of qualifying earnings, but lots of employers offer more generous terms than this.

A crucial factor in reaching your £2m goal is starting early – as the figures above show. That’s not only because it gives more time for your money to grow, but because of the magic of compounding. If you stay invested, your money quickly snowballs as investment returns get to work on ever-larger sums. 

Many people use their workplace pension as their only method of saving for retirement. But you can turbocharge your retirement savings by running a personal pension alongside workplace schemes.

You have a £2m pension, how do you turn it into income?

Amassing a pension of £2m or more is no mean feat – but even if you reach your goal, it’s not time to sit back and relax quite yet. The next challenge is to work out the best way to generate pounds and pence for your pocket.

Most financial advisers would recommend using income drawdown for some or all of your money, as it offers flexibility. You can change the level of income at any point, and retain control of the rest of your savings.

Malcolm Steel, at the independent advice firm Mearns & Company, said: “It’s essential to establish a withdrawal rate which safeguards against draining your capital too quickly, but also provides a comfortable income.

“Inflation will bite over time, so you should maintain flexibility to increase your withdrawals to meet rising living costs.”

Using income drawdown means you need to make some important investment decisions. 

“Retirement is a pivotal milestone that should trigger a revaluation of your portfolio,” said Mr Steel.

“To secure inflation-adjusted real returns over the long term, a substantial allocation to the stock market is essential. At the same time, it is important to include defensive assets like government and corporate bonds to mitigate the tremors of stock market volatility. 

“These tremors, particularly unsettling for retirees relying on their pension fund, are inevitable.”

Mr Steel suggested the classic 60pc equity-40pc bond split as a starting point.

Another consideration is to select specialist equity income funds in retirement. These funds target companies that pay regular dividends, producing a natural income to ensure (but not guarantee) consistent cash flow. 

“This can help to cushion the impact of fluctuations in the underlying share prices,” said Mr Steel.

Income drawdown is not the only answer. You can swap your pension for an income for life by buying an annuity. Rates on annuities have been improving – they’re currently close to a 14-year high – though they remain unpopular due to their inflexibility and lack of tax advantages on death.

At today’s rates, a healthy 65-year-old can turn £2m of pension savings into a fixed annual income of around £130,000 – or an inflation-linked one starting at £72,850 a year. 

If you do choose to buy an annuity, make sure you select the best rate available to you by comparing rates from a range of providers and including details about your health, many people qualify for an “enhanced” rate. Remember, once you buy an annuity, there’s no going back.

A combination of drawdown and an annuity might be in the answer, however, to offer more flexibility. Some people choose to buy a guaranteed income or use their state pension to cover essential expenditure and then discretionary spending is met by something more flexible, like drawdown.

Not forgetting tax

Remember that whatever you receive from your pension will be liable for income tax – after the 25pc tax-free lump sum has been used up. After this, an income of £100,000 from a pension will attract an annual tax bill of £27,432 – you’ll receive £72,568.

Don’t forget to factor in your state pension, which currently pays a maximum of £10,600 a year. This is also taxable income.

As soon as you start earning over £100,000, you gradually lose your £12,570 tax-free personal allowance, pound by pound.  

Have you worked out a foolproof retirement income strategy? We want to hear from you. Email:  money@telegraph.co.uk