Individual Savings Accounts (ISAs) are incredible products for targeting long-term passive income. Both the Cash ISA and Stocks and Shares ISA protect your interest, capital gains and dividends from tax.
On top of this, any withdrawals that an individual makes are safe from income tax. The trouble is, savers and investors who don’t use them to their full potential can scupper their hopes of retiring in comfort.
So what would be the best way to aim for a £1,000 monthly second income in later life? And how large would their ISA need to be?
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 will I need?
It’s difficult to predict exactly how much we’ll need for retirement. Changes to the State Pension, a rising cost of living, and our evolving individual circumstances will all influence the precise sum.
Yet it’s important to have a particular figure to aim for. I think £12,000 a year — working out at £1,000 a month — is a good target to have in mind. When added to the State Pension, I think this could deliver a decent standard of living in retirement. To achieve this, a person would need an ISA of £300,000.
For that magic £1,000 income, someone would draw down 4% of their portfolio each year. At this rate, they’d have a regular passive income for about 30 years before the well ran dry.
But what’s the best way of reaching £300k?
There isn’t a one-size-fits-all answer to this question. The perfect way will depend on a tolerance of risk and broader investing style. How much there is to invest or save, and how long they have until retirement, are other considerations.
But a simple blend of history and mathematics shows us one thing: investing too much in low-yield assets could ruin chances of reaching that £300k ISA figure.
Lets say someone has £500 to invest each month. That’s a decent amount, I’m sure you’ll agree. But if put in a Cash ISA that delivers the average return we’ve seen over the past decade, they’d have just £175,057 after 25 years.
A top fund
Now let’s say they put their £500 into a Stocks and Shares ISA instead. Based on the 10-year average return here, they’d have a spectacular £624,103 after 25 years.
Investing in the stock market carries greater risk. Returns aren’t guaranteed, and the value of an investment can go up and down. But considering an investment trust or exchange-traded fund (ETF) like the SPDR FTSE UK All Share ETF (LSE:FTAL) can be an excellent way to reduce risk while still targeting life-changing returns.
This particular fund spreads investors’ cash over the UK’s largest-listed companies as well as some smaller-cap companies. It comprises the mature, dividend-paying stocks of the FTSE 100 alongside the (mostly) growth-focused shares on the FTSE 250.
By investing in dozens of companies (360 in this case), trusts and ETFs can provide exposure to many different sectors and regions, which helps provide a steady return over time. This SPDR product’s holdings are as varied as AstraZeneca, HSBC, Rolls-Royce and BP.
On the downside, this fund may provide worse returns than a Cash ISA during stock market downturns. But as we’ve seen, a diversified ETF like this in a Stocks and Shares ISA can significantly boost passive income in retirement.
