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It may sometimes feel frustrating that, for many years, the money in a Self-Invested Personal Pension (SIPP) cannot be withdrawn. That makes it different, for example, to a Stocks and Shares ISA.
But just as someone serving a jail term may do a degree or learn a skill that they would not even think about on the outside because they had more freedom, that money being captive inside the SIPP wrapper can offer some potential benefits to the investor, in my view.
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.
Compounding is a simple but powerful wealth creator
One of those is the opportunities it offers for compounding.
Compounding basically means reinvesting investment proceeds to invest more.
Often when we talk about it we are looking at it in the context of compounding dividends. But in a SIPP, I think it is also relevant to think about capital gains. When an investor sells a share at a profit, if the funds have to keep being held in the SIPP, they can be used to buy more shares.
Here’s the power of compounding in practice
That can have significant positive impact on the value of a SIPP.
Let’s take dividends and capital growth together. At a compound annual growth rate of 6%, a £50K SIPP ought to be worth over £250K after 28 years.
That 28 years may sound like a long time, but remember, a SIPP is designed to be a long-term investment vehicle.
If someone had a £50K SIPP at the age of 27, that 28-year wait would take them to 55 – which (for now) is the earliest point at which they could withdraw money from it anyway.
Aiming for an achievable target
I think a 6% compound annual growth rate is eminently achievable.
Some FTSE 100 shares like M&G and Aviva (LSE: AV) — to name just two — currently offer yields above 6%.
Of course, dividends are never guaranteed to last, which is why the savvy investor not only chooses which shares to buy carefully but also keeps their SIPP well diversified.
Dividends are only one part of the story here. Remember that capital growth can also come into play when aiming for a target.
Aviva is a share I think SIPP investors should consider for the long term. The insurer’s dividend yield is attractive and lately it has been growing the dividend per share annually at a strong clip, following a big cut in 2020.
Meanwhile, the insurer has a market capitalisation of £15bn. Last year, the firm’s operating capital generation (using the Solvency II standards) was £1.5bn, around a tenth of market cap.
Valuing insurers can be complicated, but to me that price looks like potentially good long-term value. Aviva has a proven business model and 17m customers in the UK – more than any rival.
The upcoming Direct Line takeover could help it boost profits further, though one risk I see is integrating the business distracting management attention from the main business.
