Retirement might seem like a long way off – but it gets closer every day! A Self-Invested Personal Pension (SIPP) can be one way to build a nest egg for retirement.
Say someone hits 40 and does not yet have a SIPP, but wants to aim to draw down passive income from a SIPP once they hit the state retirement age. How might they aim to do that?
Getting into a regular habit
Current rules mean a 40 year old today will hit the state pension age at 67. That may rise but that has not yet been confirmed, so I will stick to 67.
Now, £1,000 a month is £12,000 per year. Imagine that they are willing to take out 4% of their SIPP per year after 67, as passive income. For that they would need a SIPP worth £300k.
Now, from 55, they may have been able to draw down a quarter of the SIPP’s value free of tax. To keep things simple I am going to ignore that here and use £300k at 67 as the target.
Presume that, from 40 to 67, they can achieve a compound annual growth rate on the SIPP of 5%, from dividends and capital gains (minus capital losses). They can achieve that by contributing £450 per month to the SIPP during that period.
Getting back the tax you paid
One of the features of a SIPP is the tax relief on contributions.
That can be even more lucrative for a higher or additional rate taxpayer. But even for an ordinary taxpayer it can be quite a boost.
Thanks to the tax relief, they can put £360 per month into their SIPP and the government will top it up to £450.
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.
Drawing the income
The tax relief is a positive, but one downside of a SIPP (versus, say, an ISA) is that after the drawdown allowance I mentioned above, other money taken out of it would be taxable.
So, the investor should be able to hit the target of £1,000 per month in passive income from 67 onwards as I laid out above, but note that that will be subject to any relevant taxes.
Looking to the long term
Still, I think from a standing start, for a 40-year-old to retire with a four-figure (pre-tax) monthly income for the cost of a few hundred pounds a month between now and then could be very attractive.
One share I think investors ought to consider for its long-term potential is Cranswick (LSE: CWK).
It sells for 19 times earnings, which I would ordinarily think is expensive for a food producer. But Cranswick is no ordinary food producer.
The company has grown its dividend per share annually for decades. The share price has moved up 49% over the past five years alone.
With its economies of scale, proven business model, deep relationships with UK retailers and sharp strategic focus, I think Cranswick has strong ongoing growth potential.
One risk I see is reputational. An exposé of conditions at a Cranswick piggery last year was shocking and could lead customers to seek alternative suppliers.
Hopefully though, the company will take its commitment to animal welfare seriously, in a way that helps not harms the business.
