I think a Self-Invested Personal Pension (SIPP) is a terrific vehicle for creating an impressive retirement income stream. The benefits of tax relief as well as deferral allow investors to compound their wealth significantly faster. Capital gains and dividend taxes are nowhere to be seen. And unlike an ISA, the annual allowance stretches all the way out to £60,000!
Taxes will eventually re-enter the picture once an investor starts taking out their passive income instead of reinvesting it. Yet, if everything goes according to plan, even an after-tax income stream from a SIPP can lead to a far more comfortable lifestyle. And it might only take £200 a month to do it.
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.
Capitalising on the advantages
In a perfect world, investors preparing for retirement will undoubtedly want to use as much of their annual SIPP allowance as possible. But few individuals are fortunate enough to have the financial flexibility to put aside 60 grand each year. This is especially true if they’re also trying to maximise their £20,000 ISA allowance as well.
However, regularly investing a small sum can still translate into an impressive pension when starting early. Injecting £200 into a SIPP automatically transforms into £250 after tax relief for someone paying the basic rate of income tax. That means in a single year, £2,400 will have been contributed, yet £3,000 will actually be available to invest, thanks to the tax advantages.
After 30 years of consistently putting money into this retirement account, a total of £90,000 would have been saved – £72,000 from deposits and £18,000 from tax relief. Now, let’s introduce some compounding investment returns.
Assuming a SIPP portfolio matches the FTSE 100’s historical average of 8% a year, an investor could end up sitting on a nest egg worth just shy of £375,000. That’s more than five times what an investor would have injected into their SIPP. And by following the 4% withdrawal rule, it translates into an extra £15,000 of pre-tax passive retirement income each year.
Getting more ambitious
Index investing is a proven and powerful way to build wealth. But it also prevents a portfolio from achieving market-beating returns. And that might be critical in order to succeed in the long run.
There’s no guarantee that the FTSE 100 will continue to deliver an 8% annual gain moving forward. In fact, over the last decade, this rate has started to slow. And if this trend continues, investors could be left with considerably less than expected when retirement comes around.
This is where stock picking enters the picture. Instead of buying a whole index, investors can consider specific quality companies such as Games Workshop (LSE:GAW). The Warhammer creator’s built an impressive ecosystem for its hobbyist customers, driving 18% average revenue growth and 38% operating profit margins.
There have been some bumps along the way. Energy and raw material inflation have added pressure to margins. And the steady rise of at-home 3D printing could develop into a significant threat that undercuts Games Workshop’s pricing power.
Nevertheless, investors who saw the potential in this business early could have earned an average annualised gain of 20% since 2004. And at this rate, investing £200 a month into a SIPP for 30 years translates into £5.75m with a £229,760 retirement income steam!
This post was originally published on Motley Fool
