A Stocks and Shares ISA is a tremendous way to generate a regular second income for retirement. The tax-free wrapper allows investors to build a portfolio of FTSE 100 and FTSE 250 companies offering both share price growth and dividend income.
The annual deadline for this year’s £20,000 allowance is 5 April, and with Easter in the way, there’s no time to lose. So how large would an ISA need to be to produce £750 a month in passive income? Let’s do the sums.
Investing little and often
That monthly income equates to £9,000 a year, a handy top-up to the State Pension and other income sources. And it’s completely tax-free.
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.
Under the ‘4% rule’, if an investor takes that percentage of their capital as income each year, the underlying pot should never run out. To generate £9k under that rule, an investor would need £225,000. That may seem daunting, but investing slowly and steadily can make it more achievable than many think.
Let’s take an example of someone building a balanced portfolio of FTSE 100 shares, generating an average total return of 7% a year. If they were 20 years from retirement, contributing £450 a month would give them £236,875 when they stopped working. Stretch the time horizon to 30 years and the same monthly contribution swells to £545,794. Using the 4% rule, that generates income of £1,819 a month or £21,832 a year. That’s way above my initial target.
Investors can potentially do better than 7% by selecting individual FTSE 100 stocks. That’s what I do.
Meanwhile, today’s stock market volatility also presents opportunities for those with a long-term perspective.
Standard Life offers a super-sized yield
Shares in insurer Standard Life (LSE: SDLF), which recently rebranded from Phoenix Life, have fallen around 15% in the last month. They’re far from alone, as the Iran crisis spooks investors. For long-term investors, such swings are normal. Markets fell sharply after the pandemic, the war in Ukraine and Donald Trump’s ‘liberation day’ tariffs, but soon rebounded strongly.
Standard Life’s yield has risen to a thumping 8.7%, the second-highest on the FTSE 100. That income alone exceeds the annual compound return used in my calculations above. Of course, dividends aren’t guaranteed and could be cut if the crisis persists. Before the recent shock, the board’s strategy was to increase dividend by a steady 2% a year.
There are other risks. Standard Life operates in a competitive market and has to continually deliver new business to keep the revenue cash flowing. A full-blown market crash could hit the value of the assets it holds to protect against liabilities.
Yet I hold this stock and I’m now considering buying more, to take advantage of today’s lower price and more generous yield. A spread of FTSE 100 shares like this can help build a high-and-rising passive income for retirement.
Markets are volatile but opportunities abound. Investors able to focus on the long-term can find excellent bargains out there, and potentially bag themselves an even more generous second income.
