How I’d invest a £20k ISA allowance to earn passive income of £1,600 a year

Harvey Jones is looking to generate a high and rising passive income from a portfolio of FTSE 100 shares, free of tax inside his ISA allowance.

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A Stocks and Shares ISA is a brilliant way to generate passive income, because it’s all free of tax.

I’m only into the first month of the new financial year, and haven’t started investing up to my £20,000 limit yet. So I’m sifting through the FTSE 100, looking for stocks that should generate the highest possible second income.

Not every company pays dividends, but most of the big blue-chips do. In fact, FTSE 100 stocks pay some of the most generous dividends in the world. While the index has a whole yields around 3.7%, individual stocks can pay as much as 7%, 8%, 9% and in one or two cases, even more than that.

On the hunt for yield

One of my favourite is insurer and asset manager Legal & General Group (LSE: LGEN). I’ll admit, the L&G share price performance isn’t the best. It’s down 12.91% over five years, and up just 4.02% over the last 12 months.

Yet what it’s lacked in recent capital growth, it’s made up for in dividend income. Which, remember, will be tax-free in an ISA.

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.

L&G is forecast to yield 8.88% in 2024. And because most companies aim to increase their dividends over time, that’s forecast to hit 9.37% in 2025. Which is an incredible rate of income, almost double the best cash accounts.

Unlike savings rates, dividends are never guaranteed. Once a yield edges closer to double digits, shareholder payouts can be vulnerable. Personally, I’m not expecting L&G to cut dividends, but nobody ever knows for sure.

I think the investment case is strong. L&G specialises in selling retirement products, and demand should grow with the ageing population. Especially as it is clear that the state cannot provide a comfortable retirement. It’s operating in a competitive market, though. And investors seem down on financial stocks generally.

I plan to retire on my dividends

I expected the Legal & General share price to kick on this year, but it has been held back by the dawning realisation that interest rates will stay higher for longer. That increases the returns on lower risk asset classes like cash and bonds. However, I think when inflation and interest rates do fall, the L&G share price could spark into life. Trading at 10.7 times forward earnings for 2024, it certainly looks good value.

If I could earn 8.8% a year across my £20k ISA allowance, I’d get income of £1,760 a year. However, that’s a bit ambitious. Ideally, I’d spread my ISA across five FTSE 100 income stocks, with different risk levels.

Some yield even more than L&G, such as insurer Phoenix Group Holdings, which pays income of 10.13%. Others pay less, for example builder Taylor Wimpey yields 6.88%.

I’m aiming for an average yield of 8% a year. That would give me a solid £1,600 in year one, with any share price growth on top. With luck, that would rise in time, generating the passive income I need to fund my retirement. It’s time I started populating my ISA.

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 positions in Legal & General Group Plc, Phoenix Group Plc, and Taylor Wimpey Plc. 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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