Many investors contribute to a Stocks and Shares ISA to earn passive income from the stock market. Since there’s no tax on dividends from investments held in an ISA, it’s a great way to boost returns.
However, for younger investors, there’s another wrapper that could be more appealing. I’m talking about the Lifetime ISA, which has the benefit of a 25% government bonus on contributions. Nice!
Here’s how the Lifetime ISA works and why I think investors who qualify should consider opening one to accelerate progress toward achieving their passive income aspirations.
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.
The Lifetime ISA
Investors can open a Lifetime ISA before they turn 40. After this, they can continue contributing until they’re 50. Contributions are capped at £4,000 per tax year and the government adds an extra 25%. For those putting in the maximum amount, that’s a £1,000 top-up.
When money’s used to buy stocks within the Lifetime ISA, those investments will fluctuate in value. The guaranteed government bonus applies to the initial cash contributions.
Lifetime ISAs do have restrictions. They’re popular with first-time buyers since withdrawal penalties don’t apply when purchasing your first home for £450k or less.
However, their potential as passive income vehicles for retirement is overlooked. Those aged 60 and over can also withdraw from a stock market portfolio in a Lifetime ISA penalty-free.
Maximising my income potential
To illustrate how advantageous this could be, let’s model the effect. For the calculations below, I’m assuming my portfolio grows 8% annually and I’d secure a 5% yield across my dividend shares.
Starting at 18, if I invested £4,000 annually in a Stocks and Shares ISA, here’s what my portfolio would look like when I turned 60.
| Final portfolio | Annual passive income |
|---|---|
| £1,314,332 | £65,717 |
If I contributed to a Lifetime ISA until I was 50 instead and used a Stocks and Shares ISA for the final decade, the figures look like this.
| Final portfolio | Annual passive income |
|---|---|
| £1,627,270 | £81,364 |
Thanks to compound returns, I’d earn an extra £15,647 in passive income every year without contributing a penny more than if I’d just used a Stocks and Shares ISA.
Of course, share price growth and dividends aren’t guaranteed. In reality, I might not achieve these targets if my stocks underperform or companies I invest in cut or suspend dividend payments.
An investment idea
To achieve my goals, I’ll need to buy quality dividend stocks. One worth considering is FTSE 250-listed investment platform AJ Bell (LSE:AJB). Currently, shareholders bag a 2.6% yield.
The stockbroker’s latest trading update was brimming with positive numbers. A total of 528,000 customers now use the platform — a 13% rise over a year. Assets under administration have increased 20% to reach £83.7bn.
Achieving rapid growth in a highly competitive sector’s no mean feat. The company’s direct-to-consumer (D2C) strategy’s bearing fruit.
It’s also engaging with the new Labour government to simplify Britain’s ISA system. This could be a boon for the entire sector if chancellor Rachel Reeves proves amenable.
Granted, the yield isn’t too spectacular and the forward price-to-earnings (P/E) ratio of 19.7 looks a little high, posing risks for share price growth.
But overall, AJ Bell shares merit consideration — perhaps for a Lifetime ISA offered by the company itself!
