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A Self-Invested Personal Pension (SIPP) is one of the most powerful retirement saving tools that British investors have in their armoury. Apart from providing complete control over a retirement portfolio, the tax benefits and deferral benefits can greatly speed up the wealth building process beyond what a buy-to-let can achieve.
Owning a portfolio of rental properties is a proven way to build wealth, not necessarily for retirement. It comes with the problem of dealing with tenants and property maintenance. But if done right, a lot of money can be made.
The problem is that the popularity of this method has attracted the attention of the HRMC. And as a result, direct investment in real estate is taxed more heavily compared to other asset classes like stocks. Fortunately, SIPPs do not have such disadvantages. And best of all, investors can still buy real estate using this account.
A legal way to avoid taxes
Like an ISA, all capital gains and dividends received within a SIPP are completely tax-free. But unlike an ISA, all deposits made into a SIPP qualify for tax relief depending on the investor's tax bracket. Someone paying a base rate of 20% will receive a 20% tax refund on all deposits made. In other words, for every £1,000 deposited, there is £1,250 of money you can invest.
There are caveats, of course. Cash can't usually be withdrawn until age 55 (rising to 57 in 2028). And taxes finally re-enter the picture when withdrawals begin. SIPPs follow the normal pension tax rules (which may change in the future) where the first 25% is tax-free, and the rest is subject to income tax.
But that's still a lot better than paying taxes endlessly on a rental property. Not to mention, by deferring taxes, wealth can be accumulated very quickly.
Being a SIPP real estate mogul
SIPPs provide access to the entire stock market. That includes real estate investment trusts (REITs). These are special types of companies that manage a portfolio of rental properties, which return profits to shareholders through dividends.
A SIPP protects this income from dividend taxes. But again, by owning shares in a REIT, all the hassles of property management are left to a team of professionals. It's a passive and tax-efficient way to earn rental income without going into debt with an expensive mortgage. In addition, investors are not tied to residential properties.
Look for REIT like Greencoat UK Wind (LSE:UK). Instead of buying houses, it invests in wind farms across the UK. These goods do not pay rent but sell electricity, which is needed at all times, producing a sufficient economy.
Please note that tax treatment depends on the individual circumstances of each client and may change in the future. The content of this article is provided for informational purposes only. It is not intended to be, and does not constitute, any form of tax advice. Students are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
The recurring nature of this income supports not only a 7.4% yield but also nine years of consecutive dividend increases that average a 5.7% growth rate. Of course, the journey has been volatile of late. As with any other real estate investment, high interest rates have had a negative impact on 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 a SIPP at this rate of yield will push the new pension pot into millionaire's territory within 25 years. That comes from dividends. Compared to tax-free income, the journey can be even faster.
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