Investing through a Self-Invested Personal Pension (SIPP) is a prudent way to build wealth for retirement. Apart from investor capital being sheltered from taxes while it remains in the account, it also provides tax relief to top up the account balance.
As such, building a big nest egg for retirement becomes far easier. And by focusing on dividend-paying stocks, it’s possible to plough the cash back into the portfolio and benefit from compounding to build a chunky pension passive income.
With that in mind, let’s explore how I’d invest £20,000 to earn extra income.
Growth versus dividends
Much like any investment account, SIPPs provide investors with a lot of freedom and options. Since investments are handled by the individual, the asset restrictions that hamper most pension funds don’t exist. And that means investors can pick from the entire catalogue of UK and international shares to build up a nest egg.
Therefore, buying growth stocks to build wealth in a SIPP is a perfectly acceptable strategy. And it’s one that could prove highly lucrative.
However as previously mentioned, I’m sticking to income stocks. Apart from usually offering a bit more stability, regular dividend payments can eventually build into the equivalent of a retirement salary without having to dip into my invested capital.
Investing the money
Capital gains and dividend tax aren’t a threat when building wealth in this special pension account. Income taxes do eventually enter the picture once an investor starts to withdraw funds. But the biggest advantage is the tax relief. Depending on the tax bracket, up to 45% of income tax can be refunded on each deposit.
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.
Let’s assume an investor has received an inheritance of £20k but is still in the Basic Rate band. By putting this capital into a SIPP, 20% is provided as tax relief. In other words, the investor now has £24,000 to invest.
By investing this capital into a collection of high-quality dividend shares with an overall yield of 6%, I’ve just unlocked a £1,440 passive income stream overnight. Obviously, that’s not enough to live on. But by reinvesting these dividends over the next 40 years, this retirement income could grow up to £15,780. And that’s not including any extra returns from capital gains or the potential for dividend hikes along the way.
When combined with the State Pension, this can help place someone into a far more comfortable retirement lifestyle later down the line.
However, as exciting as this sounds, it’s important to remember that investing always carries risks. And even dividend-paying stocks can occasionally become volatile. Four decades is plenty of time for multiple crashes and corrections to emerge, the timing of which could disrupt the expected timeline for hitting a near-£16k passive income.
Nevertheless, a well-managed, well-constructed income portfolio can still hugely improve retirement comfort in the long term. Therefore, it’s a risk I feel is worth taking.
