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How just £40 a month can help you beat the State Pension

The full new State Pension is £168.60 per week or £8,767.20 per year. Many retirees might struggle to live off this token income stream. However, nothing is stopping you from building your private pension savings for the future.

In fact, savings of just £40 a month could deliver a sizeable nest egg and help you beat the State Pension in older age.

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Tax benefits

One of the best tools available for investors to use to save for the future is a Self-Invested Personal Pension (SIPP). SIPPs have tremendous tax benefits. For a start, contributions attract tax relief at your marginal tax rate.

That is 20% for basic rate taxpayers. So for every £80 you contribute, the government will provide a £20 top-up to take the total to £100.

Basic tax relief on contributions of £40 a month is worth £10. That gives a total monthly contribution of £50 including the SIPP tax benefit.

In addition to this tax benefit, any income or capital gains earned within a SIPP wrapper are not liable for further tax liabilities. That being said, you will have to pay on tax on the money you withdraw in retirement if you withdraw more than your basic annual allowance.

Savings growth

When you’ve set up a SIPP and added monthly direct debits of £40, the next stage is to start investing your money.

Most SIPP providers offer a regular investment plan, which allows savers to invest a lump sum every month from as little as £30. Deciding where to invest this money is the hard part. However, the FTSE 250 is a great place to start, I feel.

Since its inception, three-and-a-half decades ago, the FTSE 250 has produced an annualised return for investors of 12%. That rate of return is enough to double your money roughly once every six years.

Investing £50 a month in the FTSE 250 at an annual rate of 12% could produce a nest egg of £254,700 after 33 years.

A nest egg of £254,700 would be enough to provide an annual income of £10,200 in retirement, easily beating the State Pension. Combined with the State Pension, a saver could achieve an income of £18,967 a year.

Long term returns

It isn’t very easy to predict what the future holds for the stock market in the short term. The economy, particularly the UK economy, faces plenty of headwinds, and we don’t know what the economic environment will be 12 months from now.

Nevertheless, FTSE 250 performance over the past three decades shows that despite its near-term challenges, over the long term, it should produce handsome returns for investors.

Over the next 10 to 20 years, it is highly probable the economy will be much bigger than it is today. This growth should lift equity prices as well.

The combination of the wealth-creating power of the FTSE 250, combined with the tax benefits available by using a SIPP, makes the perfect wealth-creating combination, to my mind.

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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.