Swapping precious time for pounds is earning money the hard way, which is why investing for passive income is so appealing. I’ve always loved the idea of cash that automatically lands in my bank account, whether I’m fast asleep or tanning myself at the beach. I’m sure I’m not the only one!
A fabulous way to generate passive income is to buy dividend stocks in a Stocks and Shares ISA. Investors don’t pay tax on capital gains or dividends from investments sheltered inside the ISA wrapper. This can supercharge potential returns.
According to a study by financial services giant Legal & General (LSE:LGEN), the happiest retirees pocket an average annual passive income of £20,400. That’s £1,700 every month. So, how big does an ISA portfolio need to be to achieve this goal? Let’s crunch the numbers.
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Buying happiness, sustainably
A key figure to focus on is the dividend yield across the stocks an investor holds within their ISA. The higher the yield, the smaller the portfolio value can be. But beware, dividends aren’t guaranteed, and any successful passive income plan should account for potential dividend cuts.
One reasonable strategy might be investing in a FTSE 100 index fund, which yields 3.12% today. With this method, a total of £653,847 invested would produce £1,700 in monthly passive income.
But that plan might be too conservative for many. A hand-picked, diversified basket of quality dividend shares could comfortably deliver a higher yield, potentially saving investors precious time and money.
For instance, at a 5% yield, an investor would only need a £408,000 portfolio. That’s nearly £246,000 less to squirrel away in an ISA than would be required using an index-only approach!
Starting from scratch, with an 8% annual total return, this target could be reached in 20 years by investing £688 into an ISA each month and reinvesting dividends. That’s an achievable two-decade route to some serious passive income.
A top UK dividend share
One FTSE 100 stock worth considering for its income potential is the company behind the happy retirement study I cited earlier — Legal & General. This asset manager and pensions provider yields a mighty 8.8%.
Dividend income is at the crux of the investment case for this stock. The firm’s commitment to a progressive dividend policy is underpinned by a robust Solvency II coverage ratio of 217%, which indicates a healthy balance sheet.
That said, forecast dividend cover is just one times earnings. Conventional investing wisdom suggests that the ratio should ideally be around two for a comfortable margin of safety. Should future earnings disappoint, dividend cuts can’t be ruled out.
One thing that makes me particularly bullish on Legal & General shares, however, is the booming bulk annuities market. In the first half, the group wrote £3.4bn of pension risk transfer business — more than double the £1.5bn achieved last year. The company has identified £1trn in global market opportunities in this arena over the next decade, so the future looks very bright.
Legal & General manages £1.1trn in assets, which makes it vulnerable to stock market downturns. That’s a concern amid growing fears of an AI-fuelled bubble. Nonetheless, overall, I think the company is still one of the best FTSE 100 income stocks to consider currently.
