Having an extra £1,000 a month in passive income is a nice chunk of change. And, in my opinion, one of the best ways to unlock this second income stream is with tax-free dividends inside a Stocks and Shares ISA.
By simply holding on to shares of typically larger and more mature businesses, investors can receive regular payments throughout the year.
On average, the UK stock market typically offers close to a 4% dividend yield. At this rate, earning an extra £12,000 requires an investment portfolio to be worth close to £300,000. However, by being more selective, a portfolio can target a payout ranging 5%-6%, bringing the required portfolio size down to as low as £150,000.
Obviously, that’s still a hefty lump sum. But once again, it’s far more obtainable than most might think. All it could take is a spare £450 each month. Here’s how.
Turning £450 into £150k
On average, UK households save around £450 each month. But once an emergency fund has been built and outstanding credit card debts are cleared, investing this capital in the stock market is a proven strategy for building substantial long-term wealth.
Assuming a portfolio ekes out a 10% average annualised return (slightly ahead of the stock market’s 8% average), investing £450 each month in an ISA would transform into £150k in roughly 13.5 years when starting from scratch.
Once a decent nest egg’s been established, all investors have to do is reallocate their capital into quality dividend stocks offering an elevated yield and watch the money roll in.
Finding winning investments
While simple on paper, earning 10% each year is easier said than done. Picking winning growth and income stocks takes careful research and significant emotional discipline.
Right now, there are plenty of income stocks offering yields within the 5%-6% range today, including British American Tobacco (LSE:BATS) at 5.7%. Historically, this tobacco giant’s been a phenomenal dividend-paying enterprise.
Weak sentiment surrounding the future of cigarettes due to ever increasing regulations has kept its yield high. Yet the group’s cash flows have remained robust, resulting in over 25 years of continuous payout hikes.
In the meantime, management hasn’t been blind to the regulatory threats, increasing its investments in healthier next-generation products like vapes, heated tobacco, and oral nicotine. And the steadily improving performance of these products is one of the reasons why this FTSE 100 stock has actually outperformed in 2025.
What to watch
So far, this all sounds rather promising, especially since the group’s balance sheet debt’s also moving in the right direction. However, like with all investments, there are risks to consider carefully.
The US vape market’s still young and highly fragmented, putting pressure on the group’s product margins. It’s a similar story for its other next-generation products, introducing significant execution risk to an ongoing transition away from traditional cigarettes.
If British American Tobacco can’t position its brands as market leaders, the firm’s impressive dividend might end up on the chopping block.
We’re certainly not at this stage yet. And it’s why the stock continues to be popular among investors seeking passive income. But with other high-yield dividend stocks on the market with lower levels of regulatory and market uncertainty, it’s not a business I’m rushing to buy today.
