Just how realistic is it to try and use an ISA to churn out passive income streams?
In my opinion, it can be pretty realistic. Some investors earn thousands of pounds a year of passive income in the form of dividends. Some earn thousands each month.
But that does not organise itself without someone taking action to set the ball rolling!
So, how big an ISA would someone need to target £2,000 per month of passive income?
Aiming for £2k a month
£2k a month works out at £24k per year. How much needs to be in an ISA to generate that level of tax-free passive income depends on the average dividend yield earned.
At a 10% yield, for example, it would be £240k. Halve the yield (to 5%) and the required amount doubles, to £480k.
Is the answer just to go for high yield shares then?
Not necessarily. Dividends are never guaranteed and a smart investor will not only look at the current yield but also consider what a share’s future yield looks likely to be. That can be based on a company’s financial outlook and other factors, such as its dividend policy.
That 5% is already well above the current FTSE 100 yield of 2.9%, but I will use it here as an illustration. In today’s market, I see it as achievable even while sticking to blue-chip shares.
Using an ISA to your advantage
Few people have £480k sitting around spare in an ISA!
Fortunately, this approach can start from scratch and build over time, taking advantage of the ISA’s annual contribution allowance.
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.
Say someone contributes £20k per year into their ISA. Imagine also that they then compound its value at 5% per year. That can be a mixture of dividends and capital growth, though share price declines could also eat into the number.
Doing that, the ISA will be worth £480k after 17 years. At a 5% yield, that will be enough to generate over £2k per month on average of passive income.
Finding a cost-effective Stocks and Shares ISA can also help, so it pays to take some time to compare options.
An income share to consider
Where to look to build the average 5% yield?
One share I think passive income hunters should consider is FTSE 100 insurer Aviva (LSE: AV). It yields 5.5% and has been growing its dividend per share each year since a big cut in 2020.
Insurance is a longstanding industry set to benefit from resilient demand. Aviva is the country’s leading insurer by some distance. That gives it economies of scale and means it has a large business.
But it also makes it vulnerable to smaller rivals trying to gain market share by undercutting it on price. That could hurt profits.
Still, I see a lot to like about the business.
The market is huge and resilient. Aviva has developed a massive customer base, has deep underwriting and price-setting experience and has been growing thanks to moves like last year’s acquisition of rival Direct Line.
