You may never achieve millionaire status during your working life, but you can make it by the time you retire. Here’s how to do it.
The first thing to say is that becoming a millionaire is not easy, unless you have a fat and juicy inheritance coming your way. It will be easier if you start as early as possible, and invest in a balanced portfolio of high yielding blue-chip stocks and attractive bargain shares, as the stock market generates the best returns over the long term.
Many do not know how much they need to save. So let’s address this by setting ourselves a fat and juicy target: £1m at the age of 65. The next step is to work out how much income that will buy you. Brace yourselves, it will be less than you think.
A 65-year-old millionaire buying a single life level annuity income for life will get a maximum income of £54,970 a year, figures from Hargreaves Lansdown show. That should give you a comfortable lifestyle, but you might have to put the yacht on hold. Also, it will get eroded by inflation. If you want the income to increase by 3% a year, the starting payout falls to just £36,970.
If you want a joint life annuity paying 50% income to a surviving partner, the payout falls to £49,890 a year, or just £32,510 with 3% annual escalation. Thanks to low interest rates, being a millionaire ain’t what it used to be. No wonder many prefer to keep their money invested through income drawdown.
The younger you are, the less you have to invest each month as your contributions have longer to grow. Your tax bracket will also have an impact. Basic rate taxpayers get 20% tax relief on pension contributions, higher rate taxpayers 40%, making saving easier. If you save through a workplace scheme, you may get an employer contribution as well. My figures exclude these variables and just look at the total amount paid in. They also assume average investment growth of 5% a year before inflation, but after charges.
Say you are starting from scratch, with no pension at all. At age 25, you will need to set aside £655 a month to make a million. If you invest well and your money grows at 7% a year, you might ‘only’ need to set aside £380 a month.
I know that looks daunting, but tax relief and company contributions will hopefully reduce the burden.
Time is your friend
Things get harder after that. At age 35, you need to set aside £1,200 a month to make a million within 30 years (or £820 if your money grows at 7%). Thereafter, it gets really daunting, because at 45 you need to set aside £2,432 a month, rising to £6,400 at age 55.
There are several conclusions to draw. First, start early as this gives compound interest more time to work its magic. Second, maximise your pension tax relief and employer contributions, or save in tax-free ISAs. Third, becoming a pension billionaire may be beyond your reach, but doing something is always better than doing nothing. Finally, investing in a balanced portfolio of stocks and shares is the best way to get there.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.