Buying shares with a Self-Invested Personal Pension (SIPP) is a powerful tactic for building retirement wealth. Perhaps it’s even better than buy-to-let.
While investing in rental property can provide a steady stream of passive income, it also comes with many headaches. Tenants don’t always pay rent on time, and repair costs can add up. By comparison, the stock market doesn’t demand as much attention, nor does it require individuals to take out expensive mortgages.
Pairing all this with the ability to bypass the taxman within a SIPP makes it the far better option, in my opinion. So let’s explore how to leverage these advantages to build a seven-figure nest egg.
Claim back taxes
SIPPs aren’t the only tax-efficient accounts out there. The Stocks and Shares ISA is another terrific tool for British investors. However, unlike an ISA, a SIPP benefits from tax relief.
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.
Whenever money is deposited into this type of account, any taxes paid on that capital is refunded. For those paying the Basic Rate each £800 inserted, a £200 top-up will be provided by the government to undo the 20% tax paid on the original £1,000 earned. And the same concept applies to those paying the Higher Rate.
Therefore, if I were to invest £500 each month for my pension, I’d only have to deposit £400 since the remaining £100 would come from tax relief. This not only reduces the personal financial burden of investing but also means I have more capital to work with, accelerating the journey to millionaire territory.
Of course, this comes with a few caveats. Taxes will eventually re-enter the picture when it comes to reaping the benefits of my portfolio in the future. Like any other pension, 25% can be withdrawn tax-free in one giant lump sum, but the rest is subject to income taxes. It’s also crucial to realise that none of this capital can be accessed until the age of 55 and that both of these constraints could change in the future, depending on government policy.
Let compounding do its thing
In the grand scheme of things, £500 is a fairly paltry sum. However, consistently investing small sums each month over the long term allows compounding to elevate a pension to new heights. Assuming an investor achieves an average 10% annualised return with their portfolio, investing half a grand each month over the course of 30 years translates into a net worth of £1.13m!
For those who’ve just started their careers, this could be the key to an earlier retirement at 55 instead of the national average of 65. Of course, I’ve made a fairly lofty assumption in this calculation. The FTSE 100 has historically only delivered gains of around 8% a year after dividends. And while the FTSE 250 has produced a more substantial 11%, neither index is guaranteed to replicate these gains moving forward.
In other words, investing in a passive, low-cost index fund may be insufficient to hit this goal. This is especially true considering another crash or correction is highly likely to occur more than once during this period. That’s why I prefer the stock-picking route.
There’s no denying it comes with more risk. But it also opens the door to potentially market-beating returns that may be required to stick to this retirement timeline.
