Turn a £20K ISA into £1,980 in annual passive income? Here’s how!

Our writer thinks that by investing in the right blue-chip shares, he could use an ISA to generate sizeable passive income streams. Here’s how.

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A Stocks and Shares ISA can be used in different ways. Some investors like to build up a nest egg in their ISA for some future time, such as retirement. But an ISA can also be used to generate passive income in the short term and beyond.

For example, if I had £20K in an ISA (or could put it in before the annual contribution deadline near the start of next month), here is how I would invest it to try and earn £1,980 in passive income each year.

The basics of good investing

My very first move would be choosing the Stocks and Shares ISA that seems best for my needs. Different investors can have their own specific circumstances, so it can pay to shop around in my experience.

Having put the £20K into the ISA, I would not invest it straight away just for the sake of it. I would only buy shares when I found ones I thought offered me a stake in a great business at an attractive price.

I would spread my ISA across five to 10 different shares, so that my overall passive income prospects would not be shellacked by a single company cutting or cancelling its dividend, which is always a real risk.

Actually, that is exactly what happened this week, when a share I own (Vodafone) announced plans to halve its dividend from next year onwards. Ouch!

Aiming for a target

To get £1,980 in passive income from my ISA, I would need to yield just under 10%. That is very rare for a blue-chip share. Indeed, one of the only FTSE 100 shares to yield over 10% right now is Vodafone – and it is headed for a cut.

Rather than focus initially on yield, I would find attractively priced shares in great companies and only then consider their yield.

At the moment quite a few FTSE 100 companies I would happily own are yielding 7% or 8%. If I could earn an average 7.5% yield in my ISA and compound the dividends, then after four years I should hit my passive income target.

Hunting for the right income shares to buy

What would be an example of such a passive income-generating share I would buy for my ISA?

One I would buy if I had spare cash to invest is British American Tobacco (LSE: BATS). Right now, the yield is 9.8%. Having raised its shareholder payout annually for decades, the company is what is known as a Dividend Aristocrat.  

A big risk facing the company is a decline in the number of cigarette smokers in many markets. That could hurt sales and profits.

For now, though, cigarettes remain big and highly lucrative business. As the company grows its non-cigarette business, I think it can benefit from the power of its brands like Lucky Strike to attract customers willing to pay a premium price.

Getting started

It is easy to over-complicate investing.

My approach to earning a four figure passive income from my ISA may sound simple. That is because it is. I am happy to let a carefully chosen selection of proven, large, profitable businesses do the hard work – and hopefully pay me some of their earnings on a regular basis!

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.

C Ruane has positions in British American Tobacco P.l.c. and Vodafone Group Public. The Motley Fool UK has recommended British American Tobacco P.l.c. and Vodafone Group Public. 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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