Soaring living costs in the UK are leaving us with less and less money to buy shares. For many investors, products like the Self-Invested Personal Pension (SIPP) are a godsend for building long-term wealth.
Offering tax relief of 20% to 45%, these popular investment products provide an extra financial boost for Britons to grow their portfolios. With that extra cash, the snowball accelerates more rapidly, as the additional money enhances the compounding effect.
There are some drawbacks, like a restriction on withdrawals before the age of 55 (rising to 57 from 2028) and tax liabilities on drawdowns. These can be significant disadvantages compared to the Stocks and Shares ISA, another widely used tax-efficient product.
Yet, the cash boost on offer can still make them no-brainer products to consider.
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.
Tax relief boost
The average adult in Britain has £514 to invest each month, according to Shepherds Friendly. But of course this amount can vary wildly depending on individual circumstances.
Let’s say someone has half of this amount to invest in shares each month (£257). If they can achieve an average annual return of 9%, they’d have a portfolio worth £470,501 after 30 years.
That’s substantially below the £941,002 that a £514 monthly investment would create.
Not even the use of a SIPP can make up this gap. Yet, it can still make a substantial difference to one’s standard of living in retirement.
With 20% tax relief applied, our investor would have a portfolio of £564,601. With 45% tax relief, that moves to £682,227. Both of those are quite a leap from that £470,000 a non-SIPP user would have made.
Targeting a 9% return
Of course that sort of return isn’t guaranteed, even with the SIPP’s tax benefits. Stock markets can go up and down and there’s no certainty of making more money than one puts in.
However, with a diversified portfolio, I’m confident this sort of return is possible over the long term. Indeed, Moneyfacts data shows the average Stocks and Shares ISA — which also protects from capital gains and dividend taxes like a SIPP — has delivered an annual return of 9.6% since 2015.
Investors can boost their chances of making a return like this by diversifying their portfolios to reduce risk and maximise investment opportunities. One quick and easy way to achieve this can be by buying an index tracker fund like the iShares FTSE 250 ETF (LSE:MIDD).
This product instantly spreads one’s capital across hundreds of UK mid-cap growth shares. Not only does this provide potential for robust capital gains. It also opens the door to sustained passive income (the index currently has a 3.4% dividend yield, higher than the FTSE 100‘s 3.2%).
A high weighting (44%) of the fund is tied up financial services companies today, creating potential turbulence if the UK and global economies come under pressure. But it also opens the door to long-term growth as the sector rapidly grows.
Exposure to other sectors (like industrials, real estate, consumer goods, and utilities) helps to offset this allocation.
With their enormous tax benefits, SIPPs can significantly help investors can maximise the returns they make from high-performing UK stocks like this.
