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How I’d invest in a Stocks & Shares ISA to generate £10k annual income

Front view photo of a woman using digital tablet in London
Image source: Getty Images

A Stocks and Shares ISA is a terrific way to invest for retirement. Sometimes I think Brits forget how lucky we are.

ISAs allow everyone to invest up to £20,000 a year in either cash or stocks and shares, and take their returns free of income tax and capital gains tax for life. Personally, I use it 100% for shares, as I expect them to easily outperform cash over my lifetime.

I’m investing tax-free for retirement

It’s easy to set up a Stocks and Shares ISA online through a low-cost broker platform such as AJ Bell, Bestinvest, Hargreaves Lansdown, or Interactive Investor, and get access to thousands of shares and collective funds such as investment trusts.

The annual deadline for using this year’s ISA allowance is fast approaching. It expires exactly six weeks today, at midnight on 5 April.

By using a Stocks and Shares ISA to invest in top FTSE 100 dividend shares, I hope to manage my overall income tax liability in retirement. While the money I withdraw from my various pensions will be liable to income tax, my ISA dividend income will not. It’s a great way of topping up my income without adding to my tax bill.

While it is possible to generate dividends from collective investment funds, I prefer to buy individual FTSE 100 stocks and shares. This should allow me to max out my retirement income, by investing in some of the most generous dividend payers.

I am building a concentrated portfolio of 12 to 15 top blue-chip stocks, which is just big enough to spread my risk while limiting the downside if one or two flounder. Income stocks Lloyds Banking Group, Persimmon, and Rio Tinto are all in there.

Illustrating the risks, Rio Tinto cut its shareholder payout today (and Persimmon last year), while Lloyds increased its dividend. Despite their varying recent fortunes, I believe that in the longer run all three will remain among the biggest yielders on the FTSE 100.

Here’s my dividend income target

At this stage, I am reinvesting all my dividends back into my portfolio, but plan to take them for income from my late 60s onwards.

Given my stock choices, I would expect my portfolio to generate an average yield of 5% a year, for life. At that rate of return, I’d only need £200,000 to hit my income target of £10,000 a year.

That is doable but it will me take time, by which I mean decades. Luckily, I’ve been investing for a couple of decades now and I’m well on my way. Investors who start young have a clear edge.

Somebody who started investing £100 a month in a Stocks and Shares ISA at age 30 would have £205,873 by age 67, assuming average growth of 7% a year. If they increased their contribution by 3% every year, they would have £296,552. On a 5% yield that would give income of £14,828 a year (although inflation will reduce its value in real terms).

An investor who is only 20 years to retirement and has no savings would have to up their game. If they invested £300 a month and increased that by 3% a year, they would have £198,722 in their pot at retirement.

Only shares can deliver this type of return and remember, it’s tax free inside a Stocks and Shares ISA.

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.

The post How I’d invest in a Stocks & Shares ISA to generate £10k annual income appeared first on The Motley Fool UK.

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Harvey Jones has positions in Lloyds Banking Group Plc, Persimmon Plc, and Rio Tinto Group. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2023