£20,000 in a new ISA? Here’s how I’d aim for a £52,920 annual second income

This writer explains how he’d take advantage of compound interest in a Stocks and Shares ISA to target a sizeable future second income.

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The new tax year for Stocks and Shares ISA contributions has just started and investors can add another £20,000 to their accounts. This is marvellous for building a second income because all price returns and dividends will be sheltered from the taxman.

Assuming I was fortunate enough to have £20k sitting in my ISA today, here’s where I’d start investing.

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.

Seizing opportunities

In any given period, there will be opportunities in the stock market. This could be in particular geographies, individual stocks, or entire sectors.

In early 2023, for example, I saw lots of attractive opportunities across the pond in US tech stocks. They had been hit hard in 2022 and were still down in the dumps at the start of last year.

Back then, I was able to invest in Alphabet shares at around 19 times earnings. Fortunately, my investment thesis proved right and the stock bounced back.

Indeed, fast-forward to today, and it’s up around 65%. However, it is now trading at about 28.5 times earnings, which doesn’t offer the same margin of safety.

Therefore, it can be pay to strike while the iron is hot.

A FTSE 100 passive income stock

So, where do I see opportunity?

Well, I think insurer and asset manager Legal & General (LSE: LGEN) offers fantastic value right now.

For starters, the stock is carrying a mammoth 8.1% dividend yield. This means if I invest my 20 grand in this stock today, I could expect to receive £1,620 in dividends every year.

That’s assuming the dividends are paid, of course, which is never guaranteed. Though I would note that the company carries capital in excess of regulatory requirements.

Plus, analysts are actually tipping a rise in the dividend. They’re forecasting a 5% increase to 21.4p per share this year. Then another 5% to 22.6p per share in 2025.

Based on these forecasts, the forward yield for next year is nearly 9%. So my £1,620 in dividends would become almost £1,800 without lifting a finger.

Even better, though not certain, I could get share price gains on top. And I think that’s entirely possible because analysts see profits and earnings per share rising through to at least 2026.

Longer term, I see plenty of growth opportunities for the firm due to an ageing population. According to the government, nearly one in seven people in the UK is projected to be aged over 75 by 2040.

As a dominant force in the UK pensions market, Legal & General should enjoy increasing demand for pension products and retirement planning services.

At 2.50 per share and with an 8.1% yield, I’m looking to keep adding to my holding.

The end game

If I let these dividends compound for 25 years, I’d end up with £140,175. Not bad for an initial £20k outlay!

That’s assuming no dividend or share price movements and no further investments. However, it’s obviously far too risky to hold just a single stock.

So let’s assume I invest a further £10k every year, while still generating an average 8.1% return. In this scenario, I could get to £882,000 in the same period.

At this point, I could start taking my dividends, leaving me with a potential £52,920 annual second income from a 6%-yielding portfolio.

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.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Ben McPoland has positions in Alphabet and Legal & General Group Plc. The Motley Fool UK has recommended Alphabet. 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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