The annual deadline for putting money in a Stocks and Shares ISA is just a couple of days away now. After that, another tax year will begin and I could start contributing using a new ISA allowance.
But why not do both? If I had a spare £20k to put in over the next couple of days – and remember, the deadline is for putting it into an ISA, not actually investing the funds – here is how I would use it to target an annual tax-free second income of £1,620 from next year.
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.
Building a passive income machine
Why would I see an ISA as a way of earning a second income?
Not all shares pay dividends, but many do. If I carefully select a diversified portfolio of blue-chip shares I expect to pay dividends in future, that could hopefully allow me to generate an ongoing second income in return for a one-off £20k ISA contribution.
How much I earn depends on the prospective dividend yield of the shares I buy.
If I can invest the £20k at a prospective yield of 8.1%, for example, I would be on course to earn £1,620 in second income next year and, indeed, potentially for many years or even decades to come.
Choosing income shares to buy
But nobody knows what will happen in the future. So, as investors, we make judgments about what we expect prospective yields to be. They may not be the same as current yields.
Right now, for example, Legal & General (LSE: LGEN) is bang on my target with its 8.1% yield.
On one hand, the FTSE 100 financial services firm looks set to keep its dividend at the current level, or even raise it as it did this year.
Demand for the financial services it offers such as retirement planning is likely to remain high. The company has a strong brand, large existing client base and a proven business model that is both cash generative and profitable.
Then again, it has cut its dividend before — during the 2008 financial crisis, for example. Uncertain markets leading to falling asset values could again hurt profits in future – and lead to a lower dividend.
Even considering that risk though, if I had spare cash to invest, I would be happy to buy Legal & General shares for my ISA.
But as all shares involve risk, I would keep my ISA diversified. That £20k would be enough to spread comfortably across five to 10 shares.
As in my Legal & General example, each time I would be looking for proven businesses with a competitive advantage in a market with high demand, combined with an attractive share price.
Making a move today
Still, my 8.1% target is ambitious. I think it is achievable — but it is over double the average FTSE 100 yield at the moment.
As I said above though, I do not need to invest before Friday’s ISA deadline – just make any outstanding contributions to make the most of my current year’s allowance.
So if I had not done so already, I would get to work immediately selecting the Stocks and Shares ISA that was best for my own financial situation.
