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.

Choosing shares for a SIPP

As a long-term investor, the sort of timeframe commonly associated with a SIPP makes sense to me. It helps focus my mind on finding shares to buy that I believe have excellent long-term commercial prospects.

An example is financial services provider M&G (LSE: MNG).

The asset manager has a customer base in the millions, operates in several dozen markets, has a well-recognised brand and can benefit from strong demand for asset management.

As the market is crowded, one risk I see is competitors pushing down profit margins. But over the long term I think M&G can do very well. It is a handsome dividend payer. At the moment, M&G shares yield 8.8%.

In recent years, the firm has raised its annual payout. It may do so again in future.