Many Britons today invest within Stocks and Shares ISAs as these are powerful, tax-efficient investment vehicles. But for those investing for retirement, a Self-Invested Personal Pension (SIPP) could potentially be a great option. That’s because these accounts can be even more powerful from a wealth-building perspective.
An attractive deal from the government
One major benefit of a SIPP is that contributions come with tax relief. Think of this as a reward from the government for saving for retirement. The amount of tax relief depends on the tax band a investor’s in. However, for basic-rate taxpayers, it’s 20% (40% and 45% for higher-rate and additional-rate taxpayers, respectively).
So if a basic-rate taxpayer was to contribute £800 to their SIPP, the government would add another £200. That total contribution of £1,000 means, essentially, a 25% risk-free return.
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.
This generous arrangement can lead to substantial wealth over the long term. Especially when returns from investments are factored in.
I calculate that if a 40-year-old basic-rate taxpayer puts £500 into their SIPP every month (£7,500 a year after 20% tax relief) and achieved an average return of 8% on their money from their investments, they’d have around £345k by 65 and £460k by 68. Not bad for someone starting at 40 and only investing £500 a month.
Note that I’ve assumed here that the current tax relief arrangement continues in the future. And this isn’t guaranteed.
Achieving 8% a year
In terms of achieving a return of 8% a year over the long run, an investor could aim to do this in several ways. They could simply consider investing in index funds.
With a simple global index fund such as the iShares Core MSCI World UCITS ETF, there’s a decent chance of achieving a return of 8% or more over the long run. Over the last decade, this fund (which could be worth considering today) has actually returned about 12% a year. However, this figure’s been boosted by weakness in the pound.
Alternatively, they could build their own portfolio of stocks. This is riskier but could mean higher returns if an investor picks the right stocks. Just look at the returns generated by Amazon (NASDAQ: AMZN) over the last 20 years.
Over the last two decades, it’s made investors around 120 times their money (in US dollar terms). In other words, had someone put $10,000 into the company 20 years ago, it would now be worth about $1.2m.
You’re never going to get that kind of life-changing return from an index fund. That said, this stock’s been far more volatile than most funds over the last 20 years – investors have had to live through some wild (30%+) falls.
I’ll point out that I think Amazon shares are still worth considering as a long-term investment today. I believe they have the potential to generate strong returns for investors in the long run, given the company’s exposure to cloud computing and artificial intelligence (AI).
However, we could see short-term share price pullbacks if there’s a downturn in technology spending or economic weakness. General market weakness is another risk.
The best of both worlds
It’s worth noting that these approaches aren’t mutually exclusive. There’s nothing to stop doing both. I actually think this is a great idea and it’s what I do.
This post was originally published on Motley Fool
