In my opinion, using a Stocks and Shares ISA is a marvellous way to build a passive income. Investing in high-quality companies makes income generation easily accessible. And the tax-efficient benefits of an ISA ensure my growing wealth doesn’t get picked apart by HMRC.
Building a tax-free passive income doesn’t happen overnight. But through steady and consistent investing, my nest egg can grow to a considerable size over the long term. Let me explain how.
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 power of a Stocks and Shares ISA
An often forgotten expense of investing is capital gains tax on positive share price movements and income tax on any dividends. Thankfully those are irrelevant when it comes to investing in a Stocks and Shares ISA since the account is immune to these taxes.
There is the limitation that I can only invest up to £20,000 per year. However, in reality, this is more than enough to build a substantial pile of money. Let’s say I’m able to spare a cool £50 a week from my salary that I don’t need for anything else. That’s roughly the equivalent of £2,600 a year.
On average, the FTSE 100 yields a return of around 8% per year. Assuming this trend continues moving forward (which isn’t guaranteed), then my weekly investments could grow into a pot worth:
- £39,639 after 10 years
- £127,623 after 20 years
- £322,916 after 30 years
- £497,016 after 35 years
35 years is close to the average working life. And retiring with a cool half a million from relatively modest weekly deposits certainly sounds enticing. Plus, following the tried and tested rule of withdrawing 4% each year after retirement, my nest egg would generate a passive income of around £19,880 per year. And best of all, because I’m using a Stocks and Shares ISA, it’s all tax-free!
My passive income has some caveats
As glorious as this future source of wealth sounds, there are several risks to consider. As we’ve seen in 2022, the stock market can be a volatile place. And a once-thriving portfolio can quickly dimmish and take years to recover.
Chances are that over the next 35 years, there’s going to be a stock market crash. And probably more than one. Depending on the timing of these inevitable meltdowns, my Stocks and Shares ISA could become afflicted and take more time to reach that £500,000 milestone.
Unfortunately, these disruptions to the passive income-building process come with the territory of investing. And it’s why I only invest money that I don’t need for any outstanding or recurring financial obligations, like the mortgage, utility bills, or car insurance. After all, the last position any investor wants to be in is being forced to sell shares at bad prices to meet living expenses.