The annual State Pension is less than £9,000 a year. As such, many retirees might struggle to survive on this meagre income. However, FTSE 100 stocks could improve your chances of beating the State Pension.
These companies offer long term growth potential that could deliver a sizeable nest egg and passive income in older age.
Long run returns
The index is unlikely to help you achieve a sizeable pension pot in the short run. Nevertheless, the FTSE 100’s long-term returns suggest that over time, the index could turn a small initial monthly investment into a substantial retirement fund.
Over the past 30 years, blue-chip stocks have returned around and 9% per annum, including dividends. Investing £50 a month in the FTSE 100 at an annual rate of 9% could produce a nest egg of £588,000 after 50 years. This would be enough to produce a yearly income of £25,280, based on the index’s current yield of 4.3%, easily beating the State Pension.
Buying the FTSE 100 today is a relatively simple process. You could even receive a benefit from the government by opening a Self-Invested Personal Pension (SIPP).
SIPPs are a great tool to save for the future because they have tremendous tax benefits. Any income or capital gains earned within a SIPP wrapper are not liable for further tax liabilities, although you will have to pay tax on the money you withdraw at the time of retirement.
In addition to these tax-free benefits, SIPP contributions attract tax relief at your marginal tax rate, which is 20% for basic taxpayers. That means for every £80 you contribute, the government will provide a £20 top-up.
Basic rate tax relief on contributions of £50 a month is worth £12.50, which gives a total monthly contribution of £62.50.
Investing £62.50 a month in the FTSE 100 at an annual rate of 9% could produce a nest egg of £735,000 after 50 years, enough to provide a yearly income of £31,605.
Difficult to predict
It’s difficult to predict what the future holds for markets in the short run. Certainly, the FTSE 100 may face challenges over the next 12-24 months. However, the index’s returns over the past 30 years show that over the long term, despite near-term challenges, the FTSE 100 can produce attractive returns for its investors.
Indeed, while some sectors have struggled to produce a positive performance over the past 10 years, others have charged ahead. The banking sector has been treading water since the financial crisis, but healthcare and defence have powered forward.
This implies investors should see a steady long-term return from the index over the next few decades as its diversification and international exposure help improve profits, despite uncertainty at home.
As well as the government tax relief available by using a SIPP to invest in the index, these returns could help you beat the State Pension, and possibly even retire early, with only a relatively small monthly contribution.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.