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The Self-Invested Personal Pension (SIPP) is one of the most powerful retirement-saving tools British investors have in their arsenal. Apart from granting complete control over a retirement portfolio, the tax relief and deferral benefits can drastically accelerate the wealth-building process far more than buy-to-let might achieve.
Owning a portfolio of rental real estate is a proven way to build a fortune, and not necessarily for retirement. It comes with the hassle of dealing with tenants and property maintenance. But when executed well, a lot of money can be made.
The problem is that the popularity of this method has drawn the attention of HRMC. And consequently, direct investments in real estate are taxed significantly more aggressively compared to other asset classes like stocks. Fortunately, SIPPs don’t have any such disadvantages. And best of all, investors can still buy real estate using this account.
The legal way to avoid taxes
Much like an ISA, all capital gains and dividends earned inside a SIPP are entirely tax-free. But unlike an ISA, all deposits made into a SIPP are eligible for tax relief depending on the investor’s income tax bracket. Someone paying the basic rate of 20% will receive a 20% tax refund on all deposits made. In other words, for every £1,000 deposited, there’s £1,250 of capital to invest.
There are some caveats, of course. The money cannot usually be withdrawn until the age of 55 (rising to 57 in 2028). And taxes do eventually re-enter the picture when withdrawals start. SIPPs follow the standard pension tax rules (which may change in the future) whereby the first 25% can be taken tax-free, and the rest is subject to income tax.
But that’s still massively more favourable than paying taxes non-stop on rental property. Not to mention, by deferring taxes, wealth can be compounded significantly faster.
Becoming a SIPP real estate mogul
SIPPs grant access to the entire stock market. That includes real estate investment trusts (REITs). These are special types of companies that own a portfolio of rental properties, returning the profits to shareholders via dividends.
The SIPP protects this income from dividend taxes. But also, by owing shares in a REIT, all the hassle of property management’s left to a team of professionals. It’s a completely passive and tax-efficient way to earn rental income without having to go into debt with an expensive mortgage. What’s more, investors aren’t bound to residential properties.
Take a look at a REIT like Greencoat UK Wind (LSE:UKW). Instead of buying houses, it invests in wind farms across the UK. These assets don’t pay rent but sell electricity, which is in constant demand, generating an ample stream of cash flow.
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.
The recurring nature of this income not only supports a 7.4% yield but also nine years of consecutive dividend hikes averaging a 5.7% growth rate. Of course, the journey has been a bit volatile of late. Just like any other property investment, higher interest rates have adversely impacted portfolio values. And Greencoat’s lack of control over falling energy prices has prevented it from adjusting rents to offset the impact.
However, investing £1,000 a month in SIPP at this level of yield would push a brand new pension pot into millionaire territory within 25 years. That’s just from dividends. When factoring in tax-free capital gains, the journey could be even faster.
