Leveraging the power of a Self Invested Personal Pension (SIPP) takes saving for retirement to a new level. There are many different ways to prepare for the end of a career. Long-term savings accounts and government bonds can offer attractive, near-risk-free returns. Meanwhile, mutual funds allow investors to put capital to work while having everything managed by a professional.
But a SIPP enables investors to take things into their own hands. By being in control, it’s possible to custom-tailor an investment portfolio capable of delivering far superior returns versus traditional retirement savings methods. And in the long run, when investing a lump sum each month, this could be the difference that pushes a nest egg into seven-figure territory.
Building wealth without taxes
Investing in the stock market comes with costs such as commissions and account fees. However, an expense that’s often overlooked is capital gains and dividend taxes. With HMRC constantly knocking at the door, the speed at which wealth builds can be slowed significantly.
But with a SIPP, that’s no longer a problem. In fact, apart from being immune to capital gains and dividend tax, putting money inside this type of account actually provides tax relief. Money that’s deposited into a SIPP is eligible for a tax refund based on an individual’s income tax bracket.
For those paying the basic rate, that equates to 20% relief. This means for each £700 deposited, investors actually end up with £875 of capital to work with. Eventually, taxes do re-enter the picture when the time comes to withdraw money during retirement. But by eliminating them during the wealth-building process, investors can end up being significantly better off.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Stocks or index funds?
By investing in low-cost index funds, investors can mimic the performance of the stock market. And over the long term, that’s proved to be quite a lucrative strategy. For example, the FTSE 100 has historically delivered average returns of 8% per year. And £875 invested each month at this rate could build a £1m pension pot within 27 years when starting from scratch.
Sadly, historical performance is rarely a good indicator of future results. There’s no guarantee the FTSE 100 will continue to deliver this rate of return over the next three decades. And should it fall short of expectations, investors may end up with less than they’re expecting.
This is where stock-picking enters the mix. For those comfortable taking a more hands-on approach to building wealth, investing in top-notch individual businesses offers the potential for market-beating returns. Of course, this also comes with additional risk.
Take BAE Systems (LSE:BA.) for example. The aerospace and defence firm has been firing on all cylinders lately as both the UK and US governments ramp up military spending. The tragic conflicts in Ukraine and Gaza are generating huge demand for the firm’s technologies, resulting in double-digit growth in sales and underlying profits.
As a result, the stock is up almost 50% over the last 12 months! But whether this momentum will continue is a bit uncertain. At a price-to-earnings ratio of 23 versus its average of 13, it suggests the stock is now trading at a premium. As such, the risk of volatility is rising. And as a business operating in a cyclical industry, once demand starts to wane, the share price could be sent tumbling.
This post was originally published on Motley Fool
