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For many, turning 40 raises the alarm of suddenly needing to prepare for retirement using a Self-Invested Personal Pension (SIPP) or other pension-building vehicles. While there’s still plenty of time to put money aside, the prospect of being almost halfway through a career can cause a lot of concern. Even more so considering, on average, 40-year-olds only have around £39,500 saved up for retirement, according to the Office for National Statistics.
When combined with the State Pension, passively earning an extra £1,000 each month can go a long way. So with that in mind, how much money does an investor need to put into their SIPP to achieve this?
Retirement income requirements
A grand a month equates to £12,000 a year. And when following the 4% withdrawal rule, investors will need to have a SIPP portfolio worth around £300,000. The good news is, thanks to the tax relief benefits of a SIPP, reaching this goal may not be as impossible as it might seem.
An investor who sits in the Basic income tax bracket can enjoy up to 20% tax relief on all deposits into a SIPP. As such, for every £1,000 that’s added gets a nice £250 top-up from the government. And someone with the previously-mentioned £39,500 in average retirement savings can steadily move this money into a SIPP, resulting in £49,375 of investable capital – 16% of the way to reaching the £300,000 goal.
From here, 40-year-olds don’t actually have to contribute any more money if they’re aiming to retire at 63. That’s because after 23 years of compounding at the 8% stock market average rate, a £49,375 initial SIPP will have grown into just over £300,000.
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.
Taking a step back
Even when starting from scratch, for those who can become disciplined savers, it’s possible to secure a decent retirement even with relatively small sums of capital. Sadly, there’s no guarantee that the stock market will deliver an 8% average return. Looking at the FTSE 100, gains over the last 15 years have notably lagged its historical average. And should that pattern continue, investors may end up with a smaller retirement income than expected.
This is where stock-picking provides a potential solution, as this opens the door to potentially market-beating returns, paving the way for an earlier retirement.
Take Diploma (LSE:DPLM) as an example. The specialist industrial distribution business has consistently maintained robust organic growth supplemented by strategic acquisitions. And revenue, earnings and margin expansion have been impressive without overleveraging the balance sheet.
As such, over the last 15 years, investors have reaped an impressive market-beating annual average return of 22%. And investing £325 at this rate cuts the timeline to reaching a £300,000 SIPP from 23 years to just under 14.
Of course, not every stock has delivered Diploma-like returns. And even Diploma still carries notable investment risk. Its bolt-on acquisitions strategy can backfire if deals don’t live up to performance expectations. At the same time, supply chain disruptions and higher input costs can create enormous headaches for this distribution business, especially if demand from customers goes into a cyclical downturn.
Nevertheless, it’s a business worth investigating, in my opinion, especially for 40-year-olds planning for retirement.
