The Self-Invested Personal Pension (SIPP) is one of the greatest tools for investors to build retirement wealth. And just like most things in finance, starting early can be hugely advantageous.
For those who’ve just kicked off their careers, retirement planning is unlikely to be near the top of the priority list. Yet the numbers show that delaying the creation of a personal pension is a critical mistake. Let’s break down the figures and demonstrate why putting £5k to work at the age of 25 is far better than £5k a year at the age of 55.
Why use a SIPP?
SIPPs provide investors with a wide array of advantages, specifically the deferral of taxes and, more excitingly, tax relief. However, this also comes with several caveats.
For example, once money has been deposited into a SIPP, it’s virtually impossible to get it back out until after the age of 55. As such, those looking to move money in and out may be better suited to a Stocks and Shares ISA instead.
Providing an individual is saving money each month, they’ll likely built a decent lump sum of savings after a few years. Let’s say at the age of 25, someone has gathered £5k that they don’t need access to. Instead of letting it sit inside a savings account, gathering minimal interest, this money could be far better served inside a SIPP.
Immediately, tax relief kicks in. Any money deposited into a SIPP automatically gets topped up by the government to refund any taxes paid. The amount of relief depends on an individual’s income tax bracket. Those on the basic rate, paying 20%, would see their £5k instantly grow to £6,250!
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.
That’s certainly not a bad start. But by putting this money to work in the stock market, things really start to get interesting.
The power of starting early
The stock market can be a volatile place in the short term. But in the long run, it’s one of the best wealth-building machines that almost everyone has access to. By investing in top-notch stocks, it’s possible to own small pieces of the UK’s most prominent companies. And as a shareholder, the average Joe can end up profiting from the success of other people’s work.
Picking individual stocks opens the door to market-beating returns. Compared to simply investing in an index fund, this strategy comes with higher levels of risk and demands far more dedication. But even if it results in earning just an extra 1% throughout a career, that can have a monumental impact on wealth.
In the UK, the average retirement age is 65. So investing £5k today at an average annualised return of 9% for 40 years would result in a pension pot worth roughly £180,550. By comparison, if someone were to leave retirement planning until the age of 55, they’d have to invest £950 a month just to catch up.
Starting late isn’t the end of the world. And it’s still possible to build a chunky pension pot even at the age of 55. But by starting early, it takes far less capital to arrive at the same point.
