How I’d invest £20k in an ISA to earn a second income of £1,650 a year

I’m looking to generate the maximum possible second income by investing in FTSE 100 dividend stocks. Here are five I’d like to buy today.

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This year’s ISA deadline is just a few days away and I’m on the hunt for dividend-paying FTSE 100 stocks to generate a second income for life.

Using the ISA contribution limit is more important than ever this year for two reasons. First, from 6 April, the annual capital gains tax (CGT) exemption is slashed from £12,300 to £6,000, while the dividend tax allowance halves from £2,000 to £1,000. Yet if I invest in an ISA, all of my dividend income and capital growth will be free of tax for life.

A good time to buy shares

Second, after the recent sell-off, the FTSE 100 is full of solid blue-chip companies offering king-size yields. I’ve counted 11 paying income of 7% a year, or more. Even a best-buy Cash ISA pays 4%, at most. Plus with shares I may get capital growth when stock values rise.

Shares aren’t for everyone. My capital is at risk if a company’s stock plummets. I could lose all my stake in the unlikely event it goes bust. Company dividends are never guaranteed, and could be slashed if cash flows can’t be maintained.

But I’m aware of the risks and mitigate them by building a portfolio of a minimum 12-15 different income stocks. So if one or two struggle, others should, hopefully, compensate. Also, I plan to hold my stock picks for the long term, which means a minimum of 10 years. This helps me look past short-term share price volatility.

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.

Sadly, I don’t have £20,000 to invest in an ISA before 5 April, having loaded up on dividend stocks last October. If I did have a full allowance, and was building my second income portfolio from scratch, I would start by targeting high-yield stocks.

Shareholder payouts can rise over time

Asset manager M&G is currently the FTSE 100’s highest of all, yielding a staggering 10.93% a year. A double-digit yield can suggest a company in trouble, and often don’t last long. But management is committed to its current payout, and reckons it will generate enough cash to cover it. It’s a risk but given the rewards I think it’s one worth taking. 

I might balance that by investing in British American Tobacco, which yields 7.56%. While smoking has gone into decline, revenues are holding up and the yield looks reliable. I can get further diversification through mining giant Rio Tinto, which now yields 7.47%. Management recently cut its dividend, but I don’t expect another one in the immediate future (although we never know).

Investing in insurer Aviva, which yields 7.49%, and housebuilder Taylor Wimpey, which yields 7.97%, helps spread my risk by giving me exposure to five different sectors.

If I invested £4,000 in each, my £20,000 would generate an average yield of 8.28%. That would give me a second income of £1,656 a year. With luck, this would steadily rise as companies increase their dividends. By the time I retire, it will hopefully be worth a lot more.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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