A Self-Invested Personal Pension (SIPP) is one of the key tools at our disposal for building a passive income for retirement.
Unlike an ISA, we get tax relief on SIPP contributions but not on withdrawals. That can be a benefit for investors in higher-rate tax bands who expect a lower band on retirement (so be sure to claim higher-rate relief via self-assessment).
The amount we can put in a SIPP is a little more complicated than an ISA, though there’s a standard annual total pension limit of £60,000 for most people. But it’s limited by our annual earnings too. Investors need to check their own individual circumstances.
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.
The nest egg
An old rule of thumb suggests we should draw down around 4% of the total value of our SIPP (or ISA) every year to provide passive income. The idea is that should leave enough capital behind to keep pace with inflation. And in real terms our future income shouldn’t deteriorate.
The average annual return from FTSE 100 shares over the past 20 years has been around 6.9%. So that sounds about right. I know inflation’s high right now, but I expect the Bank of England will get back to its target of around 2% a year before too much longer.
Doing a quick arithmetic check on that, I’d need about £450,000 in my retirement pot. That’s if I go with the suggested 4% drawdown a year.
But while I’m building my pot, I wouldn’t be taking anything out. I would, instead, reinvest any income into more shares. I’d say I could aim to get there in about 19-20 years by investing £1,000 each month — assuming the same 6.9% average from the FTSE 100.
Dividend shares
We can all invest different amounts. And younger people with more than 20 years available stand a good chance of accumulating a fair bit more. They could easily beat my passive income target of £1,500 a month.
But I reckon there’s another way to try to get ahead of the game. And that’s to go for stocks offering high dividends. Let’s look at Mondi (LSE: MNDI) as an example, with a forecast 7% dividend yield — very close to the 20-year FTSE 100 average annual return.
The company makes packaging and business paper. The chart above shows a disappointing recent share price performance, and a trading update on 6 October wasn’t great — a subdued market, with demand and selling prices suffering.
A diversified mix
A business like this can be cyclical and disproportionately affected by weak economic times. The dividend — which can’t be guaranteed — might have a few ups and downs. But I think the market’s overreacted, and as part of a diversified portfolio for retirement, I think Mondi’s definitely worth considering.
Forecasts show the dividend rising over the next few years. And they suggest the payments should be comfortably covered by earnings — which analysts think will get back to growth.
And if I can take 7% a year in dividends when I retire, I’d only need to build a pot just under £260,000 to hit my monthly £1,500. I reckon I could target that in about 14 years.
