A State Pension of approximately £8,500 per year is obviously not going to pay for a millionaire’s lifestyle. And to get what little it will provide, we’re having to wait longer and longer — who knows what the State Pension age will be when today’s 20- and 30-somethings are getting close to retirement?
We need to make better provision for our old age, and there are two key tools we can use. A Self-Invested Personal Pension (SIPP) provides tax relief on contributions (and though tax is payable on drawdown, there’s a tax-free allowance, and changes in your tax bands can help too). An Individual Savings Account (ISA) provides tax relief on drawdown, no matter how well your investments have done.
SIPPs and ISAs are good things (well, perhaps excluding cash ISAs). But what might not be obvious is the size of the nest-egg that it’s possible to accumulate.
ISA millionaires
Did you know, for example, that there are an estimated 1,000 ISA millionaires in the UK? Most of those are likely to have enough income to use up their entire ISA allowance each year (which, at the moment, means having £20,000 per year to invest), and they probably started when Personal Equity Plans (PEPs) were launched in 1986 and transferred them.
But some have smashed well through the million pound barrier in those 32 years, or less — and if you’re still in your thirties, or younger, you must have a decent chance of emulating them. And even for older investors, if you don’t have time to reach a million, you could still stash away a tidy sum for your retirement.
The first SIPP wasn’t opened until 1990, but you can essentially contribute as much as you want every year. It’s just your tax relief that’s limited, currently up to a maximum of 100% of your earnings, or £40,000 per year, whichever is lower.
Pension transfer
With rules regarding company pension schemes being relaxed in recent years, it’s also a lot easier to transfer company pensions (which you might have had for decades) into your SIPP now — and then enjoy the benefits of managing your own cash for potentially better returns than you’re likely to get from an old-fashioned annuity. The potential number of investors with millions in their SIPPs is almost unlimited.
The use of ISAs and SIPPs is only half of the story, though, and you still need an actual investment strategy for the cash you invest in them. My preference is to invest mainly in FTSE 100 stocks that pay good, progressive dividends.
The magic of compounding
If, for example, you can secure an overall annual dividend yield of 5% per year, and you reinvest the cash in more shares, it will take around 15 years to double your money. Then the next 15 years will double it again, adding twice as much to your pot as the first 15 years.
Is 5% a realistic target? Well, Royal Dutch Shell is currently expected to provide yields of around 6%. And it has never cut its dividend even once since the end of World War II. Shell seems pretty reliable to me.
And don’t forget, these returns I’m talking about are only the dividends. Over decades, you’re likely to enjoy substantial share price gains too.
