Putting money aside in a Self Invested Personal Pension (SIPP) can drastically improve an investor’s quality of life when retirement comes knocking. Apart from providing a tax-efficient way to build a sizable pension pot, investors can leverage the power of dividend stocks to establish a chunky retirement income stream.
With that in mind, let’s explore how I’d aim to build an income SIPP generating a generous 7% annual dividend yield.
Avoid high-yield stocks
Historically, the FTSE 100‘s offered investors an average dividend yield of around 4% a year. This figure often fluctuates alongside the stock market, and it currently sits at around 3.6%. Nevertheless, when picking individual income opportunities rather than investing in an index tracker, it’s possible to own shares that offer considerably more.
Right now, Phoenix Group Holdings (LSE:PHNX) currently offers a jaw-dropping 10.5% yield. That’s more than my target of 7%, so surely that makes it a terrific addition to my SIPP? Not necessarily.
It’s important to remember that yields are a function of both dividends and share prices. And right now, neither looks secure for Phoenix. The insurance titan has seen its market capitalisation tumble by a third over the last five years. And while dividends have continued to climb during this period, there’s growing concern that the gravy train may soon come to an end.
Historically, the insurance business has grown through a niche strategy of buying/issuing redundant life insurance contracts and letting them run. This translated into a lovely amount of insurance premium income with minimal amounts of claims from customers.
Sadly, this strategy’s delivered increasingly lower levels of growth as it’s becoming far less effective now that Phoenix has grown significantly. As such, management’s decided to completely change strategies, which will result in Phoenix getting into direct competition with industry titans like Aviva.
Focus on dividend growth
Right now, there’s brewing uncertainty about Phoenix’s ability to stand up to significantly higher levels of competition. That’s one of the main reasons why the shares have been sliding.
Of course, there’s always the possibility that Phoenix defies expectations and continues to thrive. And if that does happen, then today’s 10% yield looks like a bargain. But sadly, this is a fairly significant risk. And it’s one that many high-yield dividend opportunities tend to share.
That’s why some of the best income opportunities haven’t been the firms with the highest yields but rather those with the ability to consistently hike dividends over time. Companies with proven business models that generate plenty of excess cash are often able to increase shareholder payouts continuously. And after years of hiking payouts a relatively modest yield can transform into something far more impressive.
Therefore, when aiming to earn a 7% dividend yield in a SIPP, I’d focus my capital on the businesses that can grow payouts over time rather than those offering risky yields today.
This post was originally published on Motley Fool
