Investors looking to replace their salary with passive income can harness the power of a Stocks and Shares ISA to build a tax-free income stream over time. With the current ISA contribution allowance set at £20,000 per year for adults, disciplined investing and compounding returns can make this goal achievable.
Here’s an example
Suppose an investor contributes £750 per month into a Stocks and Shares ISA, targeting an annualised return of 10%. Over 30 years, these regular contributions, combined with the power of compounding, would grow the ISA pot to approximately £1.7m. This projection assumes all returns are reinvested.
Once the investor decides to retire or change focus from growth to income, they can shift the portfolio towards income. This may mean investing in dividend shares or buying debt (bonds). On a £1.7m ISA, a 5% yield would generate a tax-free income of around £85,000 per year. Because this income is produced within a Stocks and Shares ISA, it’s entirely shielded from any form of UK tax.
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.
To put this in perspective, consider a UK salary of £40,000 per year. After income tax and National Insurance, the take-home pay is roughly £32,000. That’s assuming current rates and no additional deductions. If this salary grows by 2% per year — a reasonable long-term estimate for wage inflation — it would reach about £72,600 after 30 years. However, after tax, the net income would still be below the £85,000 tax-free income generated from the ISA.
When the ISA income overtakes the salary
Based on these assumptions, the ISA-generated passive income would surpass the inflation-adjusted, post-tax salary after 30 years. In fact, the ISA income overtakes the net salary even before the 30-year mark. For example, after 25 years, the ISA pot would be just under £1m. In turn, this would produce a tax-free income of nearly £50,000 — already above the inflation-adjusted, post-tax salary at that point.
A stock for the job
Of course, investors can lose money, and there’s no guarantee of hitting 10% annual growth. However, with a sensible strategy, it can be achieved.
The Monks Investment Trust (LSE:MNKS) offers investors broad diversification across global stocks, making it worth consideration for those aiming to build a resilient, long-term ISA portfolio.
With over 100 holdings spanning sectors such as technology, healthcare, industrials, and financials, Monks provides exposure to established growth giants like Meta, Microsoft, and Amazon, as well as emerging markets leaders and innovative companies worldwide.
Its portfolio is geographically diverse, with significant allocations to the US, Europe, Asia, and emerging markets, reducing reliance on any single region.
The trust’s active management focuses on companies with above-average earnings growth, grouped into rapid growth, stalwarts, and cyclical growth categories, which helps balance risk and return.
However, investors should be aware that the trust uses gearing — borrowing to invest. This can amplify losses and as well as gains. It also may perform poorly if big US tech companies go into decline.
Nonetheless, it’s an investment trust I have in my pension and my daughter’s pension. It may not be as exciting as some of its peers, but it appears to offer a healthy mix of diversification and growth.
