The Self-Invested Personal Pension (SIPP) can be an excellent tool to build long-term wealth. And it’s not just because investors are protected from having to pay tax on any capital gains or dividends they make.
It’s also due to the healthy amounts of tax relief individuals enjoy. This ranges from 20% for a basic-rate taxpayer, to 40% and 45% for higher- and additional-rate taxpayers respectively.
Here’s how an investor could use one of these tax-efficient products to build a £1k monthly passive income in retirement.
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.
Cash vs shares
As with the Individual Savings Account (ISA), SIPP users can choose to use their invested capital in a variety of ways.
As with a Cash ISA, they can choose to hold their money in cash. Or they can choose to invest in a selection of UK and overseas shares, funds, and trusts as they would in a Stocks and Shares ISA.
Holding cash can be a good idea to manage risk, whether that be in a SIPP, ISA, or other savings product. However, having too much in savings instead of investing capital elsewhere can have a significant impact on an individual’s retirement goals.
Targeting £1k a month
Today, the interest rate on cash holdings in a SIPP ranges between around 2.5% and 3.5%. That’s pretty low, and is likely to head southwards as the Bank of England (likely) continues cutting interest rates.
Let’s see how this could impact someone’s plans for retirement.
To have a monthly passive income of £1k in retirement, one will need to have a £300,000 pension pot. To reach this goal with cash savings paying, say, 3%, someone would need to contribute £515 a month (including tax relief) for 30 years.
This is far higher than if they decided to invest their money in a FTSE All-Share Index tracker fund instead. If they chose this route, they’d need to make a far lower monthly contribution of £288*.
Alternatively, someone who could invest that £515 a month in a fund instead of holding it in cash could reach that magic £300k marker in less than 23 years (22 years and six months, to be exact*).
* Figures are based on the FTSE All-Share Index’s 10-year average annualised return of 6.2%. They exclude broker fees and fund management costs.
Fund magic
Funds such as the SPDR FTSE UK All-Share ETF (LSE:FTAL) can offer the best of both worlds to investors. Why? They allow individuals to chase higher returns while simultaneously allowing them to spread risk across hundreds of different stocks.
The FTSE All-Share encompasses the FTSE 100, FTSE 250, and FTSE Small Cap Index. In total, it consists of around 600 different companies, comprising 98% of the entire market capitalisation of the London stock market.
These include blue-chip heavyweights like Lloyds, Legal & General, and Rolls-Royce, alongside fledgling growth shares. Thus they provide investors with the chance to enjoy big returns through large capital gains as well as abundant dividend income.
They may provide poorer returns than cash during economic downturns. But as you can see, funds like this can be a great way to build money for retirement over the long haul.
This post was originally published on Motley Fool
