When it comes to retiring early, many people’s minds immediately turn to their pension. But in fact a Stocks and Shares ISA can also play a role.
How? Say someone wants to retire a couple of years early but wants to know how they could fund that. Putting money into an ISA, investing it in dividend shares and thereby setting up passive income streams could help bridge that gap.
Not only that, but the ISA could go much further.
As well as providing income to help fund those two years of early retirement, those passive income streams could potentially keep flowing for decades during retirement.
How passive income streams can be built over time
Let me illustrate with an example.
Currently, according to trade body Retirement Living Standards, a moderate retirement for one person has an estimated annual cost of £32,700.
How might that be funded from an ISA?
The amount of passive income an ISA will throw off (in the form of dividends) depends how large it is and what the average dividend yield earned is.
In this example, I will use 5% as average yield. That is well above the FTSE 100 average, but in my opinion still achievable while sticking to a well-chosen portfolio of blue-chip shares.
At that yield, the ISA would need to be worth £654k.
Taking the long term view
That is no small amount, I realise.
But it is possible for someone to build up to it over time. That process can be sped up if they compound along the way, meaning reinvesting dividends.
Over the course of 20 years, that would require annual contributions of around £19,779. That falls just within the annual ISA contribution allowance and works out at around £380 per week.
A longer timeframe could allow for someone aiming to retire early to achieve the same results with a smaller weekly contribution, again presuming a 5% dividend yield.
Here’s a dividend share to consider now
I said above that I see a 5% yield as realistic in the current market.
One share illustrating that – and that I think is worth investors considering – is FTSE 100 insurer Aviva (LSE: AV).
No share’s dividend is ever guaranteed to last and Aviva demonstrates this, having most recently slashed its payout per share in 2020.
Since then though, it has been growing handily. So, despite a 50% share price growth over the past five years, the yield still weighs in at a tasty 6.5%.
Could that price growth mean the share is now overvalued?
Aviva’s chief executive has recently used her own money to buy more shares. That strikes me as positive, but it does not necessarily mean the share offers good value.
After all, as the country’s leading insurer, I think the firm is exposed to the risk of a smaller competitor trying to grow market share by competing on price, threatening profit margins across the industry.
But Aviva’s market leadership offers it economies of scale. It has deep underwriting and pricing experience. The company has proven its strong cash generation capabilities. That helps underpin the dividend.
Its range of brands, broadened by its takeover of Direct Line, has given it wider customer appeal, in my view.
Should you invest £5,000 in Aviva Plc right now?
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Christopher Ruane does not hold any positions in the companies mentioned.
