The Self-Invested Personal Pension (SIPP) is one of many wealth-building tools unique to British investors. This special type of account allows individuals to benefit from all the tax advantages of regular pension funds while simultaneously gaining complete control.
That means strategic investors could build a lucrative dividend portfolio generating close to a 7% yield. To put this into perspective, for a £1m pension pot, that’s the equivalent of a £70,000 retirement income. By comparison, the average annual retirement income in the UK is around £14,100 as of 2023.
So how can investors achieve this lucrative endeavour?
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Rules and restrictions
SIPPs come with some significant tax advantages. The biggest is undeniably tax relief, which refunds any taxes paid on money that’s deposited into the account. That means for someone who’s on the basic 20% tax rate, every £1,000 deposited actually provides £1,250 of investment capital.
Taxes do eventually re-enter the picture when investors start to draw down on their nest egg after the age of 55 (soon to be 57 as of 2028). But until then, any capital gains and dividends earned are immune to the grubby hands of HMRC, allowing the wealth-building process to continue undisturbed.
However, there are a few restrictions. We’ve already mentioned one regarding withdrawal age. But another limits the maximum amount of SIPP contributions to £60,000 a year.
The good news is that’s more than enough to build a seven-figure pension pot in the long run. And in most cases, this allowance won’t actually be a handicap since few households actually reach this limit. But if someone is fortunate to earn enough income, there are some special carry-forward rules which can be taken advantage of.
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.
Earning a 7% yield
Looking at the FTSE 100, the average dividend yield offered by the UK’s flagship index is around 4%. Therefore, investors targeting more than this can’t rely on passive index investing to reach their goal. Instead, they’ll have to turn to picking individual stocks.
Stock picking isn’t for everyone. It demands a far more hands-on approach to index investing and often comes with significantly more volatility. However, earning a higher level of passive income doesn’t mean investors have to enter the realm of AIM-listed stocks.
Even with the market’s recent boost, there are over 100 companies across the FTSE 100 and FTSE 250 offering yields greater than 4%. More than 30 of these pay out more than 7%, including British American Tobacco (LSE:BATS), which offers almost 10% right now!
However, simply loading a SIPP full of high-yield shares isn’t likely to end well. Don’t forget a high yield isn’t always a good sign since it can be an early indicator of an incoming cut. In the case of British American Tobacco, the company continues to navigate an increasingly hostile regulatory environment against tobacco-based products.
Management’s already making moves to transition towards e-cigarettes and vaping devices, which are performing better than most initially expected. However, there continues to be concern about whether these newer products can generate the same level of cash flow in the long run. If they can’t, the firm’s impressive dividends may eventually come to an end.
Therefore, investors must always carefully analyse each opportunity to determine both likelihood of success and suitability.
