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A Self-Invested Personal Pension (SIPP) can sometimes seem like something to be put off until closer to retirement.
But the earlier someone starts with a SIPP, the more potentially powerful it could be. Here are a couple of things someone can miss out if leaving it too late.
Compounding value over the long term
A key way people increase the value of their portfolio is by compounding it. That means reinvesting dividends and capital growth to buy more shares.
A platform like a SIPP or Stocks and Shares ISA can be a force multiplier for that thanks to dividends and capital growth being able to accumulate tax-free inside them (though the SIPP can be more complicated when it comes to the tax treatment of withdrawals).
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.
Here, a long-term approach gives compounding more time to work its magic – and the effects can indeed be magical.
To illustrate, say someone invests £500 per month – equivalent to £6k per year, and compounds it at 5% annually.
If they start at 56 then by the time they reach the current State Pension Age of 66 (set to rise), it should then be worth over £77k.
But if they started a decade earlier, at 46, it would be worth around £203k by 66. Had they started at 36 – over £407k.
For the savvy planner who began at 26, by 66 their SIPP ought to be worth some £741k.
Getting tax relief along the way
Alongside the withdrawal tax treatment I mentioned above, a SIPP also disallows any withdrawals before 55.
Given such a constraint, why might someone consider it instead of an ISA?
Well, for starters, the two are not mutually exclusive. The SIPP offers a higher annual contribution allowance than the Stocks and Shares ISA, meaning it can complement it. Both can be used at once.
Also, unlike an ISA, a SIPP offers tax relief upfront.
So someone can essentially get free money to invest. The younger they start, the longer the potential timeline to benefit from that tax relief.
Hunting for inspiration?
One of the shares I hold in my SIPP is B&M European Value Stores (LSE: BME).
I think the compounding opportunity here is quite attractive. The share price has increased 67% so far this year and the dividend yield is 3.5%.
The discount retailer has a proven, profitable business model that I think may allow for bigger dividends in future. While the share price has risen steeply, it is still 56% cheaper than five years ago.
That may mean it is a possible bargain. But it also points to ongoing risks.
B&M has struggled to offer the right selection of consumer goods at the right prices to keep its shoppers filling their baskets. Aldi and Lidl’s continuing UK expansion plans could also raise competition for B&M.
Still, I reckon the share is worth considering for both its growth and income potential from a long-term perspective.
It is a proven operator with an extensive shop estate and large existing customer base. I see those all as strengths.
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Christopher Ruane owns shares in B&M European Value Retail.
This story originally appeared on Motley Fool
