How big does your SIPP have to be to target a £2,000 monthly pension income?
A Self-Invested Personal Pension (SIPP) is a brilliant way to generate a decent income in retirement. It’s how I’m saving for my own retirement. I’m building a portfolio of FTSE 100 shares, most of which pay me regular dividends twice a year, which I reinvest today but plan to draw as passive income once I stop working.
It’s always worth working out how big the pot needs to be. Letâs run through the numbers for anyone hoping to draw £2,000 a month, or £24,000 a year.
Building my retirement pot
Income from a SIPP depends on the yield on the underlying investments. For example, if a portfolio delivered income of 3% a year, a £24,000 annual income would require a SIPP of £600,000.
Increasing the yield reduces the capital required. So if the investors get 6% instead, they could reduce that target income to just £400,000.
High-yielding FTSE 100 stocks allow smaller pension pots to generate higher levels of income. I hold a spread of them in my SIPP, including insurance provider and asset manager Legal & General Group (LSE: LGEN).
Legal & General has a brilliant yield
It currently offers one of the highest dividend yields on the entire FTSE 100, a scarcely believable 8.87% over the last year. If I put my entire SIPP into this single stock I could generate that £24,000 a year income from just £270,500.
That would be madness though. It would leave my retirement income exposed to the fortunes of just one company. If the dividend was cut, as can happen, my income would plunge.
While the income is A+, the Legal & General share price gets a C- from me. Over the last year, its up just 4%, although the five-year growth figure is a little better at 24%.
Part of this is down to that generous dividends. It’s paid twice a year, and on each occasion, the share price dips to account for the money leaving the company. While the payout is generous, itâs coming at the expense of capital appreciation.
This is an issue for every high income stock, but I’ve noticed that Legal & General’s main sector rival Aviva has delivered plenty of share price growth on top of its dividend. So it isn’t inevitable.
Dividends and share buybacks
Worryingly, the Legal & General dividend is covered just once by earnings, where normally I’d like to see twice as much cover. Yet the board has indicated that it can continue to increase shareholder payouts, albeit by a modest 2% a year.
Hopefully, it will stand by that pledge, but there are no guarantees. If we get that big stock market crash everybody keeps warning about, it could prove harder to sustain.
The companyâs balance sheet is strong, reserves exceed regulatory requirements, and the board found enough spare cash to complete a £500m share buyback.
For anyone looking to build a SIPP income, I think Legal & General’s worth considering, even if the share price continues to lag. But investors should only buy with a long-term view, as part of a balanced portfolio of shares with different growth and income profiles. Over time, this approach can help turn a modest pension pot into a reliable long-term second income stream.
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Harvey Jones has positions in Legal & General Group Plc. 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.
