Why everyone should have a SIPP?

SIPP (Self-Invested Personal Pension) is explained in a separate article and I will post the link at the end, but essentially, this is a personal pension account that you manage yourself. Trust me, it’s much easier than it sounds.Anyway, let’s get into the topic statement.

The concept of pension is quite cultural in my opinion. It is wildly different in South Asian countries compared to Western society.Although things have changed recently and the number of both government and corporate jobs that provide pensions is going up, for most people in Bangladesh and South Asia, pension means what they get from inheritance or the wealth they build up with their income. For many, they are dependent on children or relatives.People can get by somehow with no income in many Asian countries—or at least they used to in the past. So “no typical pension” has been the norm and belief for many.

Hence, it is difficult for people to think about pension accounts and start saving money for the future, especially when monthly expenditure is already close to take-home pay.In my opinion, if you live in the UK, you should have a private pension pot. Period. Even if you are in the NHS or a similar pension scheme, and yes, even if you are getting a mega inheritance.Let me explain why. I believe the following will convince you to open one today.

1) Retirement is going to be more expensive than you think

Even if you have paid off your home and everything else, considering the cost of living—including energy, health (as the NHS is heading where it’s heading), transport, food, gifts, clothing, subscriptions, and all sorts of other expenses—you are going to need around £40k per year to have a decent life today without a mortgage (assuming you pay off your mortgage before retirement).Adjusting for annual inflation of 2–3%, in 30–35 years that would be about £72k–£90k per year. Even if you can survive with £30k today, in 30 years it’s going to be about £55k–£72k.

That’s after tax. Remember, your pension is taxed exactly the same as your income.So, in the best-case scenario, you will need to have £60k per year after tax. That means annual income from your pension should be around £76k.

If you follow the popular 4% rule, you will need a pension pot of £1.9 million to safely withdraw £76k per year for 30 years or so. This means if you have a pension pot of £1.9 million, you can take out 4% every year without running out of money in your lifetime.

To have this much, you would need to put in about £11.5k per year for 30 years—around £481 per month each for a couple, and about £1,000 for a single earner.If you are starting from zero and we consider a more conservative return of about 5% (very conservative, given that you can get around 7–10% based on the last 30 years of S&P 500 returns), you would have to contribute around £2,300 per month for 30 years.

If you are in a defined benefit scheme like the NHS pension, you would need to have a salary of £136k per year for 30 years to get £76k yearly after tax. That’s about £16k per year of contributions.As it is a defined benefit scheme (explained here), you contribute a certain percentage of your salary to get a fixed amount per year after retirement.

Now, this is for a single earner. Many families will have two earners contributing to the NHS pension—those families will be absolutely fine. Even for a single earner, if they are earning that amount in their workplace and are in a defined benefit scheme like the NHS, and continue for 30 years, they would be fine looking at the numbers.

The easiest thing for you would be to just contribute to NHS or similar schemes and enjoy. In the next paragraph, I will explain why you would still benefit from a SIPP.

The only trade-off if you are in the NHS pension is that you would have to work full-time until retirement age to get this level of pension, and the shorter you work, the smaller the retirement income will be.

But to be fair, if you have that much inheritance or both of you earn >£100k each per year for 30 years, you would be fine without a SIPP for the amount of money.However, remember—if you want to retire early or go part-time after 50, then your monthly pension income can go down significantly. To cover the deficit, I think you should still have a SIPP.

But if you are still not convinced, the following might help.

2) Tax efficiency

If you earn more than £50k, you pay 40% tax on that portion.If you earn over £100k, you effectively pay about 60% tax on that extra income.If you need and spend all the money from your income, then fine—but if you are in the UK and earn more than £100k (which you are likely to earn at some point in your lifetime), you are giving a huge chunk of your income to the taxman.

You don’t always need the extra money, but you still end up paying extra tax simply because you’re not aware of other options.I know it might not feel like it, especially after paying into an ISA or other savings, but after working for a few years with an income of >£100k, you will likely have disposable income. There is no point giving this much tax for no obvious reason.

57 years of age will arrive sooner than you think, so move your money to a SIPP without paying tax on that amount. You are essentially paying your future self instead of paying the taxman.

For instance, if you earn £110k a year, your take-home would be £6,029 per month, but if you move £10k to your SIPP, your taxable income becomes £100k and your take-home would be £5,713 per month.So, by taking £10k out of your income, you have lost £3,600 in annual take-home pay, but you have saved £10k in your pension—that’s over £6.4k of tax saving. I think it’s a no-brainer.

3) Retiring early

Even if you love your job, I don’t think anybody would hate the idea of being more flexible with weekly hours after a certain age and without feeling any financial pressure.A SIPP with 40% tax savings on contributions would add up quickly to a substantial amount, allowing you to partially retire early.If your NHS pension kicks in at age 68, you just need your SIPP to cover the income gap for however many years or sessions you want to reduce.

4) Other opportunities

You cannot invest in residential property through a SIPP, but you can in commercial property. You just need a particular type of SIPP called a SSAS. There is a whole different process and I will write about SSAS later.

It’s free to open a SIPP. It literally takes a few minutes, and I believe it’s a no-brainer for anyone living in the UK to open one.

My SIPP was in Vanguard, but I will move some or all of it to InvestEngine soon, as IE does not have any monthly cost, whereas Vanguard has 0.15%.

If you have come this far—well done. I fell asleep a few times writing this to be fair, but I think this is certainly food for thought.

Happy investing, everyone. Peace.