The Stocks and Shares ISA is a terrific way to generate a sizeable passive income in retirement. All capital gains and dividends are entirely free of tax for life, as are withdrawals. Every penny belongs to the investor. HMRC can’t touch it. So where to start?
Building the wealth required to generate a £2,000 monthly second income takes time. That works out as £24,000 a year, so it’s worth it. By subscribing as much as possible to every year’s ISA allowance, the money can compound and build over time.
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.
Let’s take the example of a 40-year-old, planning to retire in around 25 years. How large does their ISA need to be to generate that second income?
Stocks and Shares ISAs for income
The answer depends on how much income their portfolio produces. Let’s say an investor has a portfolio of FTSE 100 shares, delivering an average yield of 5%. To generate £24,000 a year, they’d need a pot of £480,000.
That may look daunting, but remember, the investor has a quarter of a century to get there. Over such periods, the stock market can really put money to work. Let’s assume their portfolio delivers an average return of 7% a year, roughly in line with the long-term FTSE 100 average, with all dividends reinvested.
Let’s also assume our 40-year-old is starting from scratch. In that case, they’d need to invest £600 a month, and they’d end up with £487,270. Stock market returns aren’t guaranteed, of course. They could generate much less than 7% a year, or they could generate a lot more.
Building a diversified portfolio of individual stocks gives investors the chance to outperform the market, rather than simply track it.
M&G has a high yield
One dividend stock I hold myself and really rate is wealth manager M&G (LSE: MNG). It floated free from FTSE 100 insurer Prudential in 2019, and has done pretty well since, despite the turbulence caused by the pandemic, the cost-of-living crisis and now the Iran war.
Its shares are up almost 39% in the last 12 months. That’s despite dipping 5% dip in recent weeks. Better still, it offers a trailing yield of almost 7%, lifting the total one-year return towards 45%. Of course, investors can’t expect that kind of return every year.
M&G makes its money from ‘asset management’. Basically, managing wealth on behalf of clients, and running investment funds. This puts it at the forefront of today’s stock market volatility, which could hit client inflows and the value of assets under management. M&G also has to prove its long-term worth, by outperforming cheap tracker rivals.
But over the longer run, I think it’s worth considering as part of a balanced, income-focused portfolio. The yield is one of the highest on the FTSE 100 but looks sustainable to me, with the board planning to increase shareholder payouts by 2% a year in future.
No share is without risk that’s why building a diversified basket of stocks is so important. The rewards should flow at retirement, in the shape of a tax-free second income.
