The Stocks and Shares ISA’s a brilliant opportunity to generate a tax-free passive income from equities. Sadly, I rarely have enough cash to invest my full £20,000 allowance, but that doesn’t worry me too much.
I reckon I can still produce a huge second income by investing as much as I can each year in high-yielding FTSE 100 shares.
The crucial ingredient is time. The earlier I start, the longer company share prices and reinvested dividends have time to grow.
I love dividend stocks
My retirement portfolio contains a heap of high yielders, including Legal & General Group, which has a trailing yield at 8.32%, and wealth manager M&G, which yields a blockbuster 9.53%. The financial sector’s a happy hunting ground for yields, but I’m keen to diversify.
I’ve had mining giant Rio Tinto (LSE: RIO) in my sights for several months. The natural resources sector’s highly cyclical and lately it’s been down in the dumps, as Chinese demand wanes due to the country’s struggling economy.
And that tempts me. I’d rather buy shares in Rio when they’re hated and cheap than in demand and pricey. They’ve had a bumpy period, falling 11.74% over three years, but rising 13.5% over the last 12 months.
Commodity stocks can be volatile and spring nasty surprises – Rio recently suffered a derailment on its 2,000km Australian iron ore rail network – but it tends to outperform when the economy’s on the up. When interest rates finally fall, I think it will get a leg up.
Rio Tinto isn’t dirt cheap today, trading at 9.89 times forward earnings, but it still looks pretty good value. And the key figure for this article, the yield, is pretty good at a forecast 6.14% for 2024, covered 1.7 times by earnings. It’s another building block in my passive income portfolio.
My retirement plan
My favourite FTSE 100 income stocks could give me an average yield of around 7% today. On £10k that would only give me income of £700 a year, but here’s the thing. Like everyone else, I get an ISA allowance every year.
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Now let’s say I invested £10,000 every year, while increasing it by 3% to keep pace with inflation. If I reinvested all of my dividends, within 30 years I’d have a stunning £1,386,986.
If I started drawing all my dividends as income at that point, my 8% yield would deliver income of £97,089 a year.
That’s huge, although I’ll admit my figures are pretty theoretical. I may not be able to invest £10k a year, let alone increase it by 3%. Dividends aren’t guaranteed. Several of my income stocks may cut, or drop their dividends. In that case, my yield will fall.
On the other hand, I haven’t factored any share price growth into my figures, so I could end up with a lot more.
Either way, the principal holds. Investing regular sums in top dividend stocks over a working lifetime can produce heaps of passive income. Now I’m putting my theory to the test, but adding more FTSE 100 dividend shares to my portfolio, starting with Rio Tinto.
