If you’ve ever wondered whether the State Pension will be big enough to support your lifestyle in retirement, you’re far from alone.
That’s one reason millions of people have a Self-Invested Personal Pension (SIPP), separate to a State Pension.
To illustrate how that might help top up retirement earnings, let’s walk through the process of having a SIPP as well as some pros and cons, for someone who wants to target an extra £1,000 per month in retirement.
Thinking about passive income
There are different ways a SIPP might help to boost someone’s finances alongside a State Pension.
For example, they may decide to sell some of the holdings and use that capital. Up to a certain limit of the total value, this can currently be done tax-free from 55 onwards, though that age will likely rise in future.
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.
To keep things simple, though, in this example I want to consider the situation of someone who wants to take the income from their SIPP but not touch the capital.
A target of £1k per month means £12k per year.
Let’s say someone wants to aim for a 4% average yield on their SIPP. That’s above the current FTSE 100 yield of 3.1% but still achievable, in my view, while sticking to proven blue-chip firms and having a fairly conservative approach to risk management.
That would require a SIPP valued at £300k.
Building up the SIPP value
How long would such a SIPP take to achieve?
Say someone puts in £500 each month. Thanks to tax relief that would give them £625 to invest as a basic rate income tax payer, or even more if they are a higher or additional rate income tax payer.
Indeed, this tax relief is a big advantage that has helped persuade me to have a SIPP.
Investing like that and compounding at 5% annually, it’d take 23 years for the SIPP to hit the £300k valuation I mentioned. Investing more could speed things up.
The compound annual growth rate consists of dividends plus any capital gains (though minus any capital losses), so I think the 5% is realistic.
One share to consider
One share I think merits consideration is the City of London Investment Trust (LSE: CTY). As it happens, it yields exactly 4% right now.
In fact the trust’s dividend record is stellar, as it has grown its payout per share annually for decades.
That is no guarantee things will continue that way. Dividends are never assured, though clearly the trust’s managers aim to keep the growth coming.
By sticking mostly to medium and large UK-listed companies that’ve been around for a while, the trust has a fairly conservative risk profile. That helps it to benefit from the tens of billions of pounds paid annually in dividends by FTSE 100 firms alone.
There’s a risk in such an approach, too. By tethering the trust’s performance so firmly to the UK, a downturn in British economic performance could hurt its portfolio valuation and therefore its share price.
Over time, though, I expect this investment trust’s performance might not be electrifying but should hopefully be broadly in line with that of the FTSE 100.
