There are two key reasons why I believe using Stocks and Shares ISAs is the best method to plan for retirement. First, they are not liable for income tax or capital gains tax on up to £20,000 invested each year (April 6 to April 5).
Second, unlike pensions, ISAs have no age restrictions on withdrawals. So money invested in it (up to the maximum yearly allowance) can be withdrawn anytime in any amount with no tax penalties.
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.
How much is enough?
A key question for investors is what sort of returns they should realistically aim for?
Handily, the Pensions and Lifetime Savings Association’s (PLSA) Retirement Living Standards provides a laddered guide. Currently, to have a ‘minimum standard of retirement living’, a person requires an annual income of £13,400 (more in London). A moderate standard needs £31,700, and a comfortable standard demands £43,900 (£3,658 a month).
I have always liked a bit of luxury. So if I were starting my investment journey now, I would be looking to generate £3,658 a month and I think that is a good target for other investors.
What sort of yield should be targeted?
There are basically two ways that a Stocks and Shares ISA can produce a monthly income. One is by selling stocks held in it and using the resultant capital. And the other is by leaving the capital where it is, and just removing the dividends paid by the stocks. As I want to pass the capital on to my children, I favour the latter option.
In constructing such a portfolio, I see an annual 7% dividend yield as a reasonable starting point. It is more than double the present FTSE 100 average dividend return of 3.3%. It is also a lot more than the 4.7% ‘risk-free rate’ (the 10-year UK government bond yield).
So to obtain a £3,658 a month retirement income from a 7% average annual yield would mean a total pot of £627,943.
Timing’s everything
The best piece of advice I can give younger stock pickers is to start investing as early as possible for two reasons. First, the more time available, the greater the chance stocks – and markets – have of recovering from any shocks. And second, the compounding effect on stock dividend returns can be spectacular.
So if someone started investing at 20, they could aim to retire at 50 after a standard 30-year investment cycle. This being the case, they would have to invest just under £509 a month to reach a target pot of £627,943. This would provide a monthly dividend income of just over £3,658 on an average annual yield of 7%.
A case in point
Many FTSE stocks offer this or more now, including Legal & General (LSE: LGEN) – a core choice for me in any such dividend-based portfolio. It presently has an 8.9% dividend yield.
However, analysts forecast this will rise to 9.3% this year, 9.4% next year and 9.6% in 2027.
A risk here is high competition in the sector that could reduce its earnings. It is these that ultimately drive any firm’s dividends (and share price) higher over time.
However, analysts also project that its earnings will grow by a stunning 39% a year to end-2027. Given this, and my preference for dividend stocks in my ISAs, I will buy more of the shares very soon.
