A recent survey suggested that more than half of people aged between 25 and 54 are unsure about their retirement finances. The level of the State Pension mainly concerns many investors.
Recent changes to the way the pension system works, as well as rules about how much pensioners are entitled to receive and when they’re entitled to receive it, have only complicated matters.
I believe the best way to get around these issues is to set up your own pension fund. And with one simple trick, I reckon it’s possible to build a sizeable financial nest egg and reduce your reliance on the State Pension in older age.
How to beat the State Pension
The simple trick I’m using to beat the State Pension is compound interest. Compound interest is your money making money. When combined with the tax benefits offered with a SIPP, it can dramatically improve your financial position.
In my opinion, SIPPs are the best way to save for the future. They offer tax benefits for investors when they deposit money. What’s more, any income or capital gains earned on investments inside one of these wrappers is tax-free.
The tax benefits investors receive when they put money in a SIPP varies. Basic rate tax-payers are entitled to relief of 20%. That means for every £80 contributed, the government will provide a £20 top-up, taking the total to £100.
This isn’t the only benefit SIPPs offer. By investing the money and making the most of compound interest, your savings can grow rapidly. I rekcon investors should make the most of this to beat the State Pension.
Over the past three-and-a-half decades, UK blue-chip stocks have produced an average annual total return of around 8%. As such, every £1,000 invested in 1985 is worth £16,000 today. This is compound interest in action.
Investors didn’t need to do anything to achieve this return either. All they needed to do was buy a basket of blue-chip stocks and watch their money grow.
I think savers could build a sizeable financial nest egg and beat the State Pension by using the same approach. The tax benefits that come with a SIPP would turbo-charge any compound interest growth.
For example, a deposit of £80 a month would become £100 after the tax top-up. Over 35 years, this monthly deposit could become £231,000, assuming its invested in a basket of blue-chip stocks and all dividends are re-invested.
According to my figures, a pension pot of this size would be enough to produce a State Pension-beating annual income of £9,200 in retirement.
The bottom line
That’s how I plan to make the most of compound interest to retire in comfort. If an annual income of £9,200 is unlikely to meet your spending requirements in retirement, it’s easy to earn a higher figure. All that’s required is larger monthly contributions.
A monthly contribution of £200 after the tax bonus, for example, would yield a final pension pot of £462,000 at retirement. That would be enough to provide an annual income of £18,500, easily beating the State Pension.
The post State Pension worries? I plan to retire in comfort with this simple trick appeared first on The Motley Fool UK.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020