How much does it really cost to build a big enough SIPP for retirement?

A lot of people put money into a SIPP with the intention of using it to fund their retirement.

But how big would it need to be for that?

A lot of the answer depends on someone’s individual spending patterns. We need to start somewhere, though. A helpful place is the Retirement Living Standards published by the Pensions and Lifetime Savings Association.

It shows what the cost of retirement might look like for a “minimum”, “modest”, or “comfortable” retirement. A “comfortable” retirement for one person needs an estimated £43,900 per year.

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Working backwards from a pensions goal

Now, after a certain point, someone can take capital out of their SIPP.

But, to keep things simple, let’s presume that they want a SIPP that generates £43,900 per year in dividend income.

Let’s imagine a 4% dividend yield. That may not sound ambitious but is actually well above the current FTSE 100 yield of 3.1%. When it comes to drawing income from a SIPP, people’s risk tolerance may be lower than in their younger days of still earning an income from working.

To hit that target, the SIPP would need to have just short of £1.1m in it.

Building up the pension value

While aiming to grow the SIPP without drawing income from it, the investor has some advantages.

First, there is tax relief.

For higher-rate taxpayers that can hit 40% and additional rate taxpayers can even get 45% (having paid an awful lot of tax in the first place).

But in this example we will use the basic rate tax relief of 20%. That means that, for every £1,000 you want to put into your SIPP, your cash contribution need only be £800.

A second advantage is a long-term time horizon. That can help compound value over time and let regular contributions add up.

Also, the potentially higher risk tolerance I mentioned above for a younger person not yet relying on their SIPP for living expenses means I think a 6% goal for compound annual growth while building the SIPP and not drawing income from it is reasonable.

That could come from dividends and any capital gains, but dividends are never guaranteed and shares can move down as well as up.

Here’s how much is needed!

The longer the contribution timeframe, the lower the contributions needed.

Let’s use 30 years for illustration. To hit the target above, monthly contributions of £1,093 would be needed.

Thanks to tax relief, that would be a monthly cash contribution of £875.

One share in my SIPP

One share I own in my SIPP is Pets at Home (LSE: PETS).

It yields a juicy 5.9% right now.

But the past five years have seen a share price fall of 47%. That means the current price-to-earnings ratio is 13. I think investors should consider this share.

The fall reflects some ongoing risks. The company has done a poor job of optimising its product range. If it does not get that right, sales could decline.

But its retail arm is well-established and has a popular loyalty scheme. On top of that, the company’s chain of vet practices is lucrative and growing at a good clip.

The pet care market is huge and I expect it to stay that way. With its strong market position, that is good for Pets at Home.