Building a second income from a portfolio of FTSE 100 stocks can make retirement a lot more rewarding. Investing inside a Stocks and Shares ISA is a good way to do it.
Unlike pensions, ISAs don’t offer tax relief on contributions, but the trade-off is attractive. All capital gains and dividends inside an ISA are tax-free, and there’s no income tax when you withdraw money either. That makes them a powerful way to build long-term wealth.
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.
Dividend power
Let’s say an investor was targeting a second income of £1,500 a month from their ISA. That adds up to £18,000 a year. Using the classic 4% withdrawal rule — which suggests that by limiting withdrawals to 4% each year, the capital will never run out — they’d need £450,000.
That’s a hefty sum, but thanks to the miracle of compound returns and reinvesting dividends, it can be achievable over time. Suppose they invested £375 a month into a diversified ISA portfolio that generated an average return of 7% a year. After 30 years, they’d have £454,828.
Of course, £375 a month is a lot of money. But if an investor can scrape that together, the long-term rewards should make it worthwhile. And even smaller amounts should grow nicely over time.
Banking strength
Rather than simply tracking the index, they could attempt to outperform it by building a balanced portfolio of around 15 to 20 FTSE 100 shares.
HSBC Holdings (LSE: HSBA) shares could play a role in this strategy. The bank’s share price has been on a charge lately, up 53% in the last year and 212% across five years, with dividends and share buybacks adding more value.
I avoided the bank for years, worried about political tensions between Beijing and Washington. With hindsight, that was a mistake. The lender has so far managed to balance east and west by effectively splitting into two operations, which seems to have bought some stability.
Half-year results on 30 July showed profit falling by $5.7bn to $15.8bn, dented by a $2.1bn write-down on its stake in China’s Bank of Communications and a $400m hit on Hong Kong property. Even so, the board approved another $3bn buyback and signalled confidence in its ability to withstand uncertainty.
HSBC shares still look decent value trading on a trailing P/E ratio of 10.9. Forecasts suggest the stock will yield 5.3% next year, with dividend cover of 2.1.
High growth, good value
As with every stock, there are risks. If interest rates are cut several times from here, this could squeeze margins. Washington-Beijing tensions could intensify. The Chinese economy continues to struggle, with investors now hoping for further stimulus that isn’t guaranteed to come.
After such a strong run, I’d expect the shares to slow, but I still think long-term investors might consider buying.
Even if markets stumble, ISA investors have a key advantage: patience. £450,000 may sound daunting, but with steady contributions, reinvested dividends and resilient income stocks like HSBC, it could be within reach. That’s why I see a Stocks and Shares ISA as one of the best long-term tools for building a passive income stream for retirement.
