Building a passive income stream through the stock market is a brilliant way to prepare for retirement, in my view. Both a Stocks and Shares ISA and a Self-Invested Personal Pension (SIPP) can help, and the tax advantages of each make them powerful long-term wealth builders.
ISAs don’t give tax relief on contributions, but all capital growth and dividends are tax-free. A SIPP offers upfront tax relief and shelter from tax while the money is invested, and 25% can be taken tax free. However, further withdrawals may be taxed later. ISA and SIPP tax benefits complement each other nicely, and both can help generate a reliable income in retirement.
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.
Retirement savings target
A monthly passive income of £1,500 works out at £18,000 a year. Using the well-known 4% withdrawal rule, which assumes you’ll preserve your capital if you take no amount of income each year, would require £450,000.
That’s a daunting figure, but long-term investors can get there with time. Let’s say someone invests £375 a month into a diversified ISA or SIPP portfolio that grows at 7% a year. After 30 years, they’d end up with £454,828.
Even smaller sums can add up impressively, thanks to the miracle of compound returns. Reinvesting dividends makes a huge difference, as each payout buys more shares that in turn pay out more dividends.
Barclays rewards investors
I’m always interested in income shares, and big banks have slowly rebuilt their shareholder payouts since the financial crisis. Lately, the stocks have been flying too.
The Barclays (LSE: BARC) share price has jumped almost 70% over the past 12 months and 290% in five years. Despite that, Barclays still looks cheap with a price-to-earnings ratio of 10.6, well below the market average of around 15. Its price-to-book ratio is 0.7, where anything around 1 or 2 is seen as decent value.
The trailing dividend yield is smaller than rivals at 2.36%, but Barclays tends to favour share buybacks as a way of rewarding investors. Buybacks reduce the number of shares in circulation, which boosts earnings per share and can lift the share price over time.
But some investors prefer to see more cash hitting their trading account in the form of dividends. I’m one of them. However, I’m still impressed by the board’s plans to return £10bn to shareholders via buybacks and dividends over the next few years.
As with every stock, Barclays comes with risks attached. When interest rates start falling, net interest margins will shrink, while a downturn in the US or UK could increase the number of bad loans on its books.
We’re also waiting to see whether its US operations will by affected hit by tariffs. But I still think it’s well worth considering today, as a long-term buy-and-hold.
Dividends and buybacks
No bank’s bulletproof, so I’d never put too much faith in a single stock. That’s why I prefer to hold at least 15 shares across different industries, mixing steady dividend payers with growth opportunities.
Starting early, reinvesting every dividend and sticking with it over the long term can make that £1,500 monthly passive income an achievable goal. Investors who also throw in the odd lump sum when they have cash to hand might generate even more.
