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The Self-Invested Personal Pension (SIPP) is a powerful vehicle to build wealth for retirement. Not only is it suited to long-term investing, but the tax relief top-ups from the government can act as additional rocket fuel for the compounding process.
In April 2024, the median annual salary for full-time employees in the UK was £37,430, according to the Office for National Statistics. How large would a SIPP have to be to generate this much in passive income?
Breaking things down
Assuming an investor used the benchmark 4% withdrawal rate, the portfolio would need to be just under £937,000. To some people, that might sound like an overly optimistic sum to aim for (and it undoubtedly gets more challenging to achieve the older one starts).
But for a basic-rate taxpayer at 40, it’s actually doable with an average rate of return (around 8.5% for the UK stock market, with dividends reinvested). In other words, they wouldn’t have to back risky ‘moonshot’ stocks to achieve this goal. Solid compounders would do the trick.
Let’s say this 40-year-old is in a position to contribute £900 every month. This becomes £1,125 due to the extra £225 added as tax relief. Across a year, these contributions would total £13,500. And after 23 years of compounding at 8.5%, the SIPP could grow to £937k.
Of course, tax policies may change in future. But as things stand, these figures show that it’s possible to go from scratch to almost £1m investing £900 a month in a brand new SIPP.
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.
Aiming for higher
Would that be enough to fund early retirement? Well, it might be, depending on one’s individual circumstances. But there’s the thorny issue of inflation, which has been running higher than the Bank of England would like for some time now.
Ideally then, an individual stock-picker would want to aim for a higher return than 8.5%. This adds risk, of course, because it’s far from guaranteed. But with the right level of research and a long-term mindset, it’s certainly possible.
I say this because there have been numerous UK stocks that have produced market-busting returns in the past two decades. For example, take Scottish Mortgage Investment Trust (LSE:SMT). Over the last 20 years, this FTSE 100 trust has returned around 1,400% (roughly 14.5% annualised).
However, this doesn’t include dividend increases. Because, while being overwhelmingly focused on capital growth, Scottish Mortgage has also increased its annual dividend for 42 consecutive years.
Granted, the starting 0.4% dividend yield today is miniscule. But over long periods, consistently rising dividends don’t do any harm to returns.
Sometimes a bumpy ride
I should mention that Scottish Mortgage rarely goes up smoothly in a straight line. The trust can underperform for stretches of time due to the volatile, growth-oriented stocks it holds. Any big sell-off in Nasdaq stocks is a key risk.
But Scottish Mortgage asks to be judged over periods of five to 10 years. This gives enough time for its bets on powerful future trends — including artificial intelligence, the digitalisation of finance and commerce, healthcare innovation, and the space economy — to play out.
It also aligns perfectly with those SIPP investors who have enough time to patiently ride out the inevitable ups and downs. The stock remains one of the largest positions in my own pension portfolio, and I think it’s a worthy candidate for investors to assess for a SIPP today.
