How I’d aim to turn a £20k ISA into a £226,100 second income!

As a British investor, capitalising on the tax-free ISA allowance accelerates the wealth-building process and helps build towards a second income.

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Building a second income through a Stocks and Shares ISA isn’t as complicated as many might think. By simply buying and holding quality dividend-paying enterprises, investors will regularly receive payouts that can serve as tax-free extra income, or a source of capital for reinvestment. Best of all, it doesn’t actually need that much capital to get the ball rolling. Here’s 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.

Investing regularly

ISAs are a fantastic wealth-building tool, thanks to the tax advantages they provide. This does come with the caveat of only being able to inject up to £20,000 each tax year. But this limitation isn’t a problem for most people since few actually have the financial capacity to maximise it each year. That’s not too surprising, given it’s the equivalent of investing £1,667 a month.

The good news is that even those who can only comfortably spare a couple hundred pounds each month can still achieve lucrative results.

Owning income-generating stocks

When a company generates more money than it spends, it can use it in various ways. Growth stocks typically let any free cash flow accumulate on the balance sheet. But more mature enterprises may choose to return it to its owners, its shareholders.

Dividends are a way to do that.

Looking at the FTSE 100, the average payout from Britain’s most mature enterprises is around 4%. With a £20k ISA, that’s the equivalent of £800 in annual passive income. While that’s nice, it’s hardly life-changing. And it’s even less for those unable to hit the £20k target each year.

However, by reinvesting any dividends received in the short term, compounding can work its magic much faster. It can further be accelerated by being a bit more selective, targeting higher-yielding stocks. While this does come paired with additional risk, it can easily bolster a portfolio’s yield closer to 6% with a total return in double-digit territory.

 Investing £20k a year at 10% for three decades would lead to a portfolio worth £3.8m, generating an income stream of £226,100 a year! And even if an investor could only muster a spare £500 each month, that’s still enough to build a seven-figure portfolio with a five-figure second income.

A top dividend stock to buy now?

As marvellous as it would be to earn such a huge tax-free income stream in the long run, it’s not guaranteed. Sadly, every investment, even the seemingly ‘safe’ ones, carry risk.

Picking the right stocks to build an income portfolio is crucial. But this can be quite a complex task, especially for beginners. Having said that, Londonmetric Property (LSE:LMP) might be a good place to start.

The firm owns and operates a vast network of industrial real estate across the country, leased out to various businesses. It’s a highly cash-generative enterprise that lends itself nicely to providing a steady stream of dividends. In fact, the firm recently hiked its shareholder payouts for the eighth year in a row.

Of course, the threat of higher mortgage rates has taken its toll. And continued economic weakness will likely make cash flow expansion difficult. But with the long-term demand looking promising, this stock could be a good way to kick off a diversified portfolio. At least, that’s what I think.

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.

Zaven Boyrazian has positions in LondonMetric Property Plc. The Motley Fool UK has recommended LondonMetric Property 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.

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