A SIPP is a brilliant way to generate a second income in retirement. Especially if combined with a Stocks and Shares ISA. So why do they work so well together?
With a Self-Invested Personal Pension, the tax benefits come right at the start, in the shape of upfront tax relief on contributions. Here’s what each £100 invested a SIPP actually costs, depending on your tax bracket:
- Basic rate 20% taxpayer – £80
- Higher rate 40% taxpayer – £60
- Additional rate 55% taxpayer – £55
Better still, 25% of SIPP withdrawals are tax-free. However, the remainder may be subject to income tax. By contrast, there’s no upfront tax relief on an ISA. Instead, all withdrawals are tax-free. Splitting a retirement pot across these two tax wrappers helps investors manage income withdrawals to minimise their tax bills in retirement.
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.
So how big should your pot be?
Right now, a popular choice is to build a diversified spread of FTSE 100 shares that offer both dividend income and growth. So how much does an investor need to generate a monthly income of £997, which adds up to £11,964 a year?
The answer comes down to the yield on the portfolio. Under the so-called safe withdrawal rate, investors can take 4% of their pot each year, without eating into the underlying capital. If they can generate a 5% yield from a portfolio of higher-yielding FTSE shares, they can get the same income from a smaller pot. They’ll need even less capital with a 6% yield, as this list shows:
- 4% – £299,100
- 5% – £239,280
- 6% – £199,400
I can see some fabulous dividend yields on the FTSE 100 today. One of my favourite income stocks is wealth manager M&G (LSE: MNG), which I hold in my own SIPP.
Should income seekers consider M&G shares?
When I bought it in 2023, the yield was nudging 10%. Sadly, it’s not that high today, but a forward yield of 6.9% is still pretty excellent. So why has it fallen? It’s not due to any cut in the dividends. They’ve been climbing steadily, and the board aims to hike payments by a modest 2% a year. Instead, the yield has been compressed by the rising share price. It’s beaten my highest hopes, up 43% in the last year. Throw in that trailing yield and the total return climbs to 50%.
Investors shouldn’t expect the M&G share price to grow like that every year. This is more of an income play than a growth stock. If the stock market crashes due to Iran, it will take a beating too.
The board also has to keep finding new lines of business to generate the cash required to fund those shareholder payouts. But with a long-term view, I think this is a compelling income and growth opportunity. A spread of high income shares like this one can help investors maximise their passive income, whether in a SIPP or an ISA. Or better still, both.
