This investing tactic can turn a Self-Invested Personal Pension (SIPP) into a lifelong passive income-generating machine with just £25k. Earning money while sleeping’s a proven strategy for achieving financial freedom. And for those seeking a life of luxury during retirement, building a lucrative income portfolio’s critical.
Unleashing the power of a SIPP
While ISAs have plenty of tax advantages, they pale in comparison to a SIPP if chunky retirement income’s the goal. That’s because, unlike an ISA, SIPPs provide tax relief that can automatically inject more capital into a brokerage account.
Let’s say an investor has £25k in the bank and is ready to kickstart a portfolio. If they’re in the Basic Rate income tax band, that means they’re entitled to a 20% refund on any deposit made into a SIPP. So £25k would actually turn into £31,250. That’s an extra £6,250 just for using this special investing account.
Obviously, this comes with several caveats. For one, investors can’t take their money out until they turn 55 – a threshold that’s likely to increase. And while capital gains and dividends are tax free, income taxes will eventually re-enter the picture when the time comes to start making withdrawals.
Nevertheless, building wealth in a tax-free environment with relief is an incredibly powerful advantage that most investors aren’t capitalising on.
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.
Investing £31,250 in UK shares
Once a SIPP’s set up and funded, the big question becomes where to invest. The easiest answer is with an index fund. These automate almost all of the investing journey, requiring little research or portfolio oversight to grow wealth. The only downside is that the generated income can pale in comparison to a custom-tailored portfolio.
For example, right now, the FTSE 100 offers a dividend yield of around 3.6%. However, there are plenty of individual FTSE shares offering yields that are significantly higher, some even going beyond 8%. So should investors start snapping these up instead?
Stock picking is a more complex approach to investing, requiring far more dedication and discipline. But, as previously highlighted, the increased risk comes with the potential for significantly higher returns.
Let’s look at a classic example of a high-yield stock, British American Tobacco (LSE:BATS). Not everyone is keen on part-owning a cigarette company. And this thinking is ultimately what encourages the firm to pay and maintain a whopping 8.8% dividend yield – more than double what the FTSE 100 pays.
The best income stock to buy?
Turns out cigarettes are still popular even with the known health problems they can cause. So feelings aside, does that make this business a perfect addition to an income SIPP? Not necessarily.
It’s true that dividends have been growing steadily for decades, but the share price hasn’t enjoyed the same story. Increased regulatory uncertainty within the tobacco industry’s making the future of this enterprise fairly opaque.
Even management’s recognised the winds are shifting, putting a lot of capital behind its newer non-combustible products. Yet it seems the firm’s struggling to hit its initial targets for these new items, giving rise to more questions about long-term sustainability.
So while the yield’s high, it may not stay that way forever. And sustainability risk is something investors must consider before adding any dividend stock to their SIPP.
The post Here’s how I’d invest £25k in a SIPP to get passive income for life appeared first on The Motley Fool UK.
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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
