Here’s how I’m building my SIPP to target a £5,000 second income each month

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The Self-Invested Personal Pension, or SIPP, is simply an excellent vehicle for building retirement wealth and earning a second income. Apart from shielding a portfolio from the taxman while it grows, SIPPs offer investors the enormous advantage of tax relief. And as a result, the compounding process can be accelerated by years!

That’s why I’m already using this investment tool to grow my own pension pot. And in the long run, my goal is to earn £5,000 each and every month without needing to lift a finger in effort. Here’s how.

Setting objectives

My SIPP is designed to do one thing: generate passive income.

But rather than relying on index funds, I’m carefully selecting individual stocks that show the greatest long-term potential in the pursuit of market-beating returns. Then, when retirement comes knocking, I’ll be following the 4% withdrawal rule. That means I’m aiming to take out only 4% of the value of my portfolio each year. I’ll leave the rest to continue compounding.

So, to earn £5,000 a month, or £60,000 per year, that means my SIPP will need to reach a total value of £1.5m. It’s an ambitious target. But despite what many investors might think, this goal is far from impossible.

Reaching £1.5m

On average, the FTSE 100 has delivered an annual return of roughly 8% per year. Thanks to the tax relief benefits of a SIPP, if I were to add £500 to my pension portfolio each month, I’d actually end up with £625 of capital. And investing £625 at an 8% rate translates into a £1.56m portfolio in roughly 36 years.

But like I said, I’m not relying on index fund. Instead I’m crafting a custom portfolio targeting above-average returns of at least 12% per year. That’s enough to cut almost a decade off the waiting time, opening the door to an earlier retirement.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

The challenge of 12%

Reaching an average annualised gain of 12% a year is no easy feat. But one stock from my SIPP that I think is on track to deliver market-beating returns is Melrose Industries (LSE:MRO).

This little-known aerospace & defence enterprise sits at the heart of the global aircraft value chain, supplying industry titans like BAE Systems, Rolls-Royce, and Lockheed Martin, among others. In fact, its components and technology can be found on board 70% of all widebody and narrowbody aircraft worldwide.

Melrose shares currently trade at a fairly modest forward price-to-earnings ratio of 16.9 versus an industry average of 35. And that’s despite the company targeting 20% annualised profit growth between now and 2029, along with free cash flow set to grow from £100m to £600m over the same period.

Are there risks? Of course.

Melrose is currently undergoing a pretty radical restructuring. Beyond the execution risk this entails, it’s also complicating the group’s financial reporting, masking the impressive progress the business has made. At the same time, the company is already grappling with supply chain disruptions of its own. These have been a bit of a handicap for near-term growth, sparking volatility in its share price.

Nevertheless, the combination of substantial growth potential and a cheap-looking valuation is pretty rare. That’s why, I’ve already bought some shares. And if my hunch is correct, the success of Melrose, brings me one step closer towards earning a £5,000 monthly second income.

The post Here’s how I’m building my SIPP to target a £5,000 second income each month appeared first on The Motley Fool UK.

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Zaven Boyrazian has positions in Melrose Industries Plc. The Motley Fool UK has recommended BAE Systems, Melrose Industries Plc, and Rolls-Royce Plc. 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.

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