Investing within a Self-Invested Personal Pension (SIPP) is one of the best ways to build retirement wealth in the UK. By leveraging the various tax advantages, investors can grow a £500k nest egg at an accelerated pace compared to a regular brokerage account. Let’s explore how.
Refunding taxes
SIPPs provide two major tax advantages. First, there are no capital gains and dividends taxes on investments. And second, each deposit provides tax relief.
The first benefit is also provided by a Stocks and Shares ISA, which is a bit more flexible. After all, unlike a SIPP, investors can access and withdraw their capital before the age of 55. However, it’s the second advantage of a SIPP that makes it such a powerful tool.
When contributing money to a private pension with an employer, the money’s added before taxes enter the picture. Money flowing into a SIPP often has already been taxed. Therefore, the government provides a tax refund to undo this expense.
For example, let’s say an individual is in the 20% income tax bracket. For every £1,000 deposited, they actually get £1,250 of capital to invest.
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.
Investing regularly
To maximise the wealth-building effects of compounding, investors should aim to inject fresh capital into a portfolio on a regular basis. And depositing £500 each month, or £625 after 20% tax relief, is more than enough to build a substantial pension pot.
Let’s assume an investor manages to replicate the typical 8% annualised returns generated by the stock market. Investing £625 a month at this rate would translate to a £500,000 portfolio within approximately 24 years when starting from scratch.
That means those who’ve just entered their 30s have more than enough time to build a chunky pension pot by the time they turn 55. But what about those starting a bit later?
Accelerating wealth creation
There are two ways to bulk up a retirement portfolio, either by increasing the money being deposited, or seeking higher investment returns. Not everyone has the luxury of injecting more capital. So that’s where stock picking enters the picture.
By focusing on investing in individual companies rather than an index as a whole, investors open the door to potentially chunkier gains. And even a few extra percentage points can make a world of difference in the long run. However, this investing strategy comes with added challenges and risks.
Let’s take a look at Lloyds (LSE:LLOY) as an example. The banking giant is one of the most popular investments in the UK held by both institutional and retail investors. And it’s not too difficult to understand why. As a critical piece of Britain’s economy, the bank has proven to be fairly stable, delivering dividends along the way.
Yet despite these desirable traits, the stock’s actually been a fairly terrible investment over the years. Low interest rates have made it challenging to turn a meaningful profit. And while the recent rate hikes have been beneficial, its also increased the risk of customers defaulting on their loans.
Every business carries risks, even the most popular ones like Lloyds. And a poorly constructed portfolio could result in an investor’s SIPP being far smaller than expected when retirement comes knocking. But by taking a disciplined approach, these risks can be managed and wealth built.
This post was originally published on Motley Fool
