How to target a £1m pension pot to retire early

My wife has a big – but happy – retirement problem. His £1m pension pot is so large it could lead to a huge tax bill. I know, rich people’s problem, urgh. However, this fund is the result of hard work and long-term investment of more than 30 years.

A £1m pension fund can be tax-deductible

By working harder and investing more, my husband has increased his retirement income. However, the taxman’s Lifetime Allowance limits how big a pension pot can grow.

In 2011-12, this was at £1.8m, but fell to £1m in 2017-18. It is then raised over time, to £1,073,100 in 2022-23. My husband’s pension is valued at this limit. Any excess above this threshold will be taxed at 55% if taken as a lump sum, or 25% if taken as income or drawdown. Yawis.

Create a fat fund

My husband’s retirement is in two parts. The tax put the final salary pension at £440,000. The rest is an investment fund worth more than £600k, funded mostly by paying extra contributions over decades.

What’s surprising is that two-thirds of his pot (£400k) comes from long-term investment returns. This shows the incredible power of compound interest, rolling up the return of shares over decades.

Compound interest is an excellent tool

Even now, I can still build a £1m pension pot without generous employer support. If I invest £300 a month for 40 years, my total contribution will be £144,000. But if this pot grows at 8.5% a year compounded, the total return on my investment will be £968,856. And my total fund will be worth £1,112,856

In short, with dedicated long-term investments, building a £1m pension pot is possible. But how, starting today?

I own 20+ dividend stocks

My husband partially built his investment pot by investing in various low-cost index-tracking funds. But as a Veteran value investor, I want to mimic (or beat) those returns by buying London-listed dividend stocks.

I would define the target as the 8.5% per year used in the above calculations. I want to get at least half of this (4.25% a year) from cash dividends and the other half from capital gains made by selling shares at a profit.

The good news for me is the British blue chip FTSE 100 The index has been packed with shares that offer dividend yield to the market for long-term investors like me. Currently, Footsie itself pays a cash yield of around 3.7% per annum.

However, I count at least a dozen large companies that pay dividends above the benchmark of 4.25% annually. This dividend dynamo includes major banks (eg Barclays and Lloyds Banking Groupgiant mining company (Rio Tinto), asset manager (Legal & General Group) and telecommunication companies (The Vodafone Group).

Finally, my husband and I already own all five of these dividend stocks in our family portfolio. And we aim to make more of these and other cheap UK stocks in the future!