The Motley Fool

Story by Christopher Ruane

How I’d invest a £100K SIPP to target £8K in dividends annually

A SIPP can be a useful way to generate income, whether to draw down now (in some cases) or reinvest to build the long-term value of the SIPP.

I think the current stock market offers some excellent opportunities for me to generate income in my SIPP while investing in blue-chip FTSE 100 dividend shares.
Here is how I could use a £100K SIPP to target £8K annually in dividends.

A word about compounding
Before I go on, let me explain why I mentioned building the long-value of a SIPP by reinvesting dividends earned from the shares I own in it.

That is known as compounding. Legendary investor Warren Buffett compares compounding to pushing a snowball downhill. As it goes, it picks up more snow and in time that picks up snow.

In the case of a SIPP that ‘snow’ is money from dividends – and my timeframe can be long enough for the impact to be sizeable.
If I compound a £100K SIPP at 8% annually for the next 25 years (without adding a penny of new capital), at the end of the period it will be worth around £684,00 and earn me some £54,780 in dividends annually. That could be very handy retirement income!

Targeting an 8% yield
To earn £8K annually from a £100K SIPP, I need to earn an average dividend yield of 8% (after the impact of fees; in reality, I would choose my SIPP carefully as over a long time period such fees can eat into my returns a lot).

But I would not start just by looking for high-yield shares. After all, dividends can be cancelled at any moment.

I would look for what I think are good businesses with some competitive edge that can help them to do well in a sizeable, resilient market. Only then would I consider yield.

As 8% is an average, I could invest in shares with a lower yield as long as I still achieved my target overall. I would diversify my SIPP across a range of shares to reduce the impact if one of the shares performed poorly or axed its dividend.

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If the above SIPP achieved a yield of 8% in its first year, currently easily

achievable with a portfolio of Investment Trusts, tks to Mr. Market.

And then compounded at 8% for 25 years, your ‘annuity’ would be £54.78k.

Remember to account for inflation.

The amount of capital wouldn’t be of concern, because if u wanted

to continue to withdraw your dividends, u couldn’t withdraw your capital,

unless in an unexpected emergency.

You you would also keep control of your capital to leave

it to whoever u wanted too but pse remember those

wee cats and dogs.

It’s unlikely that u will be able to re-invest at 8% for 25 years but

there is usually some unloved IT to invest in.