With dividend taxes rising and ISA allowances falling, the Self-Invested Personal Pension (SIPP) is becoming increasingly important. Offering a blend of tax advantages and free government cash, investors have an excellent chance to build a decent passive income.

Naturally, opinions will differ on what constitutes a ‘decent’ income in retirement. But I believe Pensions UK research is a good starting point — this implies a single person needs £43,900 a year (excluding tax) to retire in comfort.

That works out at roughly £3,658 a month. So how large would your SIPP have to be to generate that?

Tax questions

Unlike with a Stocks and Shares ISA, SIPP investors need to consider tax costs when calculating future passive income. While shielding holders from capital gains and dividend taxes, they don’t provide protection from income tax on withdrawals.

This doesn’t make them unattractive investment products, mind. The tax relief (which ranges from 20% to 45%) on contributions can — when factoring in the compounding benefits over time — supercharge the size of one’s pot to more than offset tax costs.

But payments to HMRC nonetheless need to be factored into the equation. Investors can take 25% as a tax-free lump sum, with the remainder charged depending on one’s tax band.

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.

SIPP size

Taking into account all of this, someone seeking a £43,900 annual (or £3,658 monthly) net income would need a gross SIPP income of £62,718 a year.

But how large would our investor’s portfolio need to be to generate this sum? It depends on what they plan to do with it — withdrawing a set percentage each year, purchasing an annuity, or buying dividend shares are all popular strategies.

My own plan is to invest in dividend-paying shares yielding around 7%. If someone seeking a £62,718 income before tax took this route, they’d need a SIPP worth £896,000.

Conquering the world

But investors need to take care when buying dividend stocks with especially high yields. Unusually large cash payouts can signal financial instability or unsustainable distributions.

It’s therefore important to build a diversified portfolio of (perhaps 15 or more) stocks to reduce risk and deliver a stable income. It’s also critical to find companies with strengths like competitive advantages, multiple revenue streams, and healthy balance sheets.

Funds like the iShares World Equity High Income ETF (LSE:WINC) can be great short cuts to achieving this. With holdings in 370 companies, returns are well protected from weaknesses in one or two regions or industries.

This in turn can provide a large and reliable dividend over time. What’s more, significant cash holdings and investment in government bonds provides additional stability for income investors.

A focus on stocks leaves the fund sensitive to broader stock market movements. While risky on one hand, it also allows the fund to harness the long-term growth potential of equity investing. It’s risen 7% in value since launch in March 2024.

With a 9.6% forward dividend yield, it’s the sort of fund I think could deliver an exceptional SIPP income.