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For British investors, the Self-Invested Personal Pension (SIPP) is arguably one of the most powerful tools in their arsenal when planning ahead for retirement. Apart from eliminating the annoyance of paying capital gains and dividend taxes, capital injections into a SIPP portfolio come with a nice chunk of tax relief.
Of course, taxes do eventually re-enter the picture when it comes to drawing down on a SIPP portfolio. But being able to compound returns for decades without HMRC dipping its grubby fingers can vastly improve investor wealth. That’s why the sooner an investor is able to start, the better. So much so that investing exactly £621.99 each month could be the key to growing a £5m SIPP in the long run. Here’s how.
The power of tax relief
When money’s injected into a private pension through an employer, this allocation of capital always happens before taxes are paid. The same concept applies to a SIPP. But because the money that goes into a SIPP has already been taxed, any deposits get automatically topped up by the government, essentially acting as a form of tax refund.
The amount of relief investors get to enjoy ultimately depends on which income tax bracket they fall into. For this example, let’s assume an investor’s paying the Basic Rate of 20%. That would mean that adding £621.99 each month inside their SIPP actually gives them £777.50 of investment capital. And that’s more than enough to start building a seven-figure nest egg.
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.
Reaching £5m before retirement
On average, most people tend to work for around 40 years before retirement comes knocking. Assuming that an investor achieves an average annualised return of 10% over these four decades, investing £777.50 each month is all that’s needed to reach £5m. And for those who can successfully push their returns to 12%, the journey gets shortened by five years, potentially paving the way to an earlier retirement.
Obviously, this is easier said than done. The FTSE 100 has historically only delivered around 8% annualised returns. And while the FTSE 250 has landed closer to 11%, it’s been quite the volatile journey since its inception in 1992. Not to mention that there’s no guarantee either of these indices will continue to deliver such returns moving forward.
As such, investors striving for a £5m SIPP will likely have to turn to stock picking. When executed well, this strategy could deliver spectacular returns that may even exceed 12%. But a poorly constructed or managed portfolio could just as easily lag the market, or even end up destroying wealth.
Which stocks could deliver 12% annualised returns?
There are a lot of promising companies on the London Stock Exchange capable of delivering a chunky double-digit return in the long run. One firm from my portfolio that continues to impress is Alpha Group International (LSE:ALPH).
The business provides a suite of financial solutions for small- and medium-sized businesses, from managing foreign exchange risk to executing global transactions. After years of defying expectations, the share price has skyrocketed by almost 830% in the last seven years! That’s an annual average of 37.5%.
Moving forward, I wouldn’t expect to see the same level of growth. But that doesn’t mean the growth story’s over. And with Alpha barely scratching the surface of its target market opportunity, its long-term potential could make it the perfect candidate for delivering the needed returns for a £5m SIPP.
Of course, it’s not without its risks. Competition in this space is fierce and heating up. And if Alpha can’t stay ahead of its smaller peers while outmanoeuvring its larger ones, the gains may fall short of expectations.
That’s why, as with every portfolio, investors should never put all their eggs in one basket.
