Investing in a self invested personal pension (SIPP) can seem daunting (or even unimportant) if you’re working and retirement is many years away. However, the maths shows it’s vital to start saving and investing as early as possible to let compounding take maximum effect. This will drive up your savings and your annual income once you stop working.
To maximise the value of a SIPP, I’d suggest being guided by these key factors: costs, tax benefits, increasing your contributions in line with earnings, and paying in as much as you can afford.
Costs? Yes, management charges on a SIPP over many years can really eat into what you can retire on. Take care to minimise these costs and keep as much money as you can for yourself.
Also, SIPPs are tax-efficient and can be made more so if you use a salary sacrifice scheme. It means less money goes to the taxman via national insurance.
Adding more money
If I made a personal contribution of £50 per month and my employer added 3% of my salary to a pension which is already worth £10,000, then I can expect a pension pot of around £116,000 or £5,350 per annum. This also assumes 5% annual growth (which seems reasonable), a 1.5% annual management charge, and that I retire at 67 (which is in about 40 years’ time).
It’s clear that adding more money while many years from retiring is the big lever that can be used to increase the value of a SIPP. If all other factors are kept the same but I increase the amount I contribute to just £100 a month, then my SIPP becomes worth £153,000, which is £7,050 per annum.
Upping my monthly input to £150 per month – and keeping everything else the same – raises the amount I can expect at retirement to £189,000, the same as £8,720, showing just how vital setting aside money is.
But just having a SIPP is not enough, it is what you do with it that counts and all that money needs to find a good home. To me, the stock market is the place for it. For a SIPP, the best investments depend on your circumstance and risk tolerance. The nearer to retirement you are, the better it is to reduce risk – this will likely mean holding some money as cash and investing mainly in larger, established companies and having a diversified portfolio. That could mean FTSE 100 blue-chips that pay reliable dividends, a tracker fund, or even purchasing investment trusts or funds that are administered by professionals.
With a longer timeframe and high tolerance of risk, it could be better to invest in individual shares on a growth trajectory and adventurous funds to try to bolster returns and exceed the average returns. This may include holding a mixture of shares listed on AIM. These are typically smaller companies and riskier for investors but you could mix them in with the shares of more established firms like those more international blue-chip FTSE names.
In the end, investing £50 is a start to investing in a SIPP, but retiring comfortably will require greater amounts if possible. Ultimately the more you put in, the more the government will also add and the more money you can spend on shares. And of course, the better the amount come retirement will be. So I suggest cracking on and investing in a SIPP now.
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Andy Ross owns no shares 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.