You may have seen the story surface yesterday about Britain’s biggest individual retirement pot. In case you missed it, a freedom of information request by RBC Brewin Dolphin found someone on these shores has amassed a whopping £11million in pension savings.
If you think this is an isolated case, you might be in for a surprise. Estimates suggest some 46,000 people have pension pots worth £3 million or more - enough to fill half the seats at Wembley Stadium.
For anyone who’s kept tabs on developments within the pension space in recent years, this may raise a few questions. None more so than that, until April anyone with pension savings worth more than £1.07 million could be hit with eye-watering tax charges when benefits were taken.
To give a rough calculation, if Britain’s £11 million pension potholder had started drawing their fund in February 2023, they could’ve faced charges of up to £5 million!
However, as is often the case with pensions, it’s not always that simple. We might assume that anyone with millions tucked away in pensions breathed a sigh of relief when the lifetime allowance (LTA) was scrapped earlier this year. But it’s possible that the holder of Britain’s biggest pension pot had already protected at least some of their fund from the LTA charge. I delve deeper into that further down.
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But first, what we all really want to know is what steps did they take to save such a mammoth sum? Saving hard? Having the skill to select the right stocks, trusts, or funds? Or was it just a massive slice of luck?
This is tricky to answer because it isn’t clear whether this is a defined contribution (DC) or a final salary defined benefit (DB) scheme. And there’s nothing that really gives this away. It could be either.
But whichever it is, it’s safe to say anyone who has amassed an eight-digit pension pot would’ve needed to contribute, and have the money invested, for many years. Making sound investment decisions can go a long way, but you can’t grow an £11 million pot unless you’ve paid plenty in.
As we’ve seen with the UK’s batch of ISA millionaires, while most successful investors have undoubtedly backed the right horses, the one characteristic that most share is that they’ve made the most of their allowance every year over a long timeframe.
But what about the pension restrictions?
Saving into a pension is slightly more complicated than topping up an ISA.
One of the biggest hurdles in recent years has been the tightening of various allowances. As noted above, until April 2023 there was a £1.07 million limit on what your pension can be worth without facing hefty tax charges. Annual contributions were restricted to £40,000 and big earners and those already retired might have seen payments capped at £4,000 a year.
It stands to reason that whoever owns Britain’s biggest pension must’ve been a big earner. We can safely assume their pot was built long before the tapered annual allowance was introduced in 2016. The taper has gone up this year, but still restricts tax relievable contributions to as little as £10,000 for anyone earning £260,000 or more.
But in years gone by, pension allowances were a lot more generous.
The annual allowance, which is the maximum you can pay into a pension every year and get tax relief, was previously much higher than its current level of £60,000. Between 2006 and 2011, someone could have contributed a total of £1.175 million into pensions and received tax relief at their marginal rate, provided they had the income to support it. There was also no tapered annual allowance, so those with big incomes did not face extra restrictions.
Year Annual allowance
The LTA used to be a lot higher, too. It started at £1.5 million in 2006 before rising incrementally to £1.8 million by the 2010/11 tax year.
The LTA was introduced as part of pension simplification - otherwise known as A-Day. On any amount that exceeded the LTA, you were charged 25% on anything taken income, and 55% on lump sums drawn.
But prior to the LTA there was no cap on what you could save into a pension during your lifetime and be hit with punitive tax charges. And although annual contributions were capped during the 1990s and early 2000s, with no LTA charge in place savers could maximise pension payments over many years without a ceiling. And perhaps most importantly, they weren’t penalised for investing wisely.
A few years before A-Day’s introduction, the government estimated that around 5,000 people had pension funds that were worth £1.4 million or more. Though a report by the National Audit Office in 2003 thought this was a bit light, putting the number closer to 10,000. It seems highly likely that the person with Britain’s biggest pension pot was part of this group.
What’s more, anyone who reached A-Day with total pension funds larger than the LTA could protect any excess. There were two types of protection available: primary and enhanced.
If the individual had registered for primary protection, they weren’t granted full exemption from the LTA. Instead, they received an enhancement factor based on the value of their fund on 5 April 2006.
Here’s an example:
So, if their total pension savings were worth £3 million, the calculation would be as follows:
(£3 million-£1.5 million)/£1.5 million = an enhancement factor of two.
This meant that when the LTA increased to £1.8 million in 2010/11, their personal LTA would’ve ticked up to £3.6 million.
Interestingly, those who registered with primary protection could continue to make pensions contributions. But if this tipped their pot past their enhanced LTA then they could suffer an LTA charge.
Enhanced protection worked in a different way. It was introduced to provide full protection against the LTA and could also protect the member’s tax-free cash.
There was, however, a catch. If further pension contributions were made, or there was further benefit accrual under a DB scheme, enhanced protection would be lost.
It’s possible that Britain’s biggest pension saver had pension savings which exceeded the LTA in 2006, registered for enhanced protection to shield their pot from the LTA, and then invested wisely over the following 17 years, propelling their savings to eight digits. And, importantly, this would mean that their fund would not be subject to either a 55% or 25% LTA charge.
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Did they ignore the allowances?
A further consideration is that you can exceed both the LTA and the annual allowance. Though you might not get tax relief or face an LTA charge, it some cases it can make sense.
For instance, if a worker receives sizeable employer pensions contributions, the benefits for breaching of LTA or annual allowance (most likely the taper) could outweigh the drawbacks. Employer payments are effectively free money, so anything they pay in, regardless of the tax or charge implications, are a bonus.
Could it be a DB scheme?
So far, I’ve largely assumed the £11 million pot has been accrued through DC savings. But could it be DB? The simple answer is yes.
DB works in different way to DC. Rather than paying into a pension and accumulating a pot, you secure a guaranteed income based on the number of years you’ve worked at a company, and your final or average salary. An accrual rate is then applied.
For instance, you have worked at a company for 40 years, your average salary was £50,000, and the accrual rate is 1/60. This would secure you an annual retirement income of £33,333.33 (40/60 x £50,000).
If you want to transfer your DB pension to a defined contribution one, the scheme applies what’s called a cash equivalent transfer value (CETV). In short, this is the pot you could exchange your guaranteed income for.
This is typically a multiple of 20-25 but can be higher or lower. A few years ago, members were apparently being offered multiples of 50.
But if we took a multiple of 25, to arrive at a CETV of £11 million, the member’s DB pension would need to generate guaranteed income of almost £450,000 a year. Not out of the question for someone who’s worked at a company for decades and held a top position, such as CEO.
We must not overlook that DB schemes accruals are also tested against the LTA and annual allowance. So again, these must be factored in.
And of course, we can’t rule out the individual holding a combination of both DC and DB, or a DB scheme that was recently transferred to DC. I spoke with a financial adviser yesterday who said he’s seen a few DB transfers in the £5 million ballpark that he reckons could've doubled in value since.
What can we learn from any of this?
An eight-digit pension pot is a pipedream for most of us. We just want enough money to afford to do the things we want in retirement.
But if there’s anything we can take from this, it’s the importance of saving for later life over a long timeframe. Starting as soon as possible really is the key. It puts a lot less pressure on you to make larger contributions when you get older and serves to highlight the power of compounding.
While a pension pot of £11 million might far out of reach, you can secure yourself a comfortable retirement, which is the holy grail for many savers.
And the good news is, now that the LTA has been lifted, you can save and invest without the worry of being hit with a heavy tax charge when you come to draw an income.
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