The ability to invest up to £20,000 per year in an ISA and not pay a penny tax on the passive income it can generate can be life-changing.
In the 2023/24 financial year, the latest for which we have the numbers, UK adults held 15m ISA accounts. And the total cash invested in those ISA accounts came to £103bn! So we’re a nation of canny savers and investors, right? Well, we need to dig a bit deeper.
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Pick the right one
Of those 15m ISA accounts, 9.9m were Cash ISAs — and only 4.1m were Stocks and Shares ISAs. Cash ISAs held £69.5bn, but only £31.1bn — less than half that amount — went into Stocks and Shares ISAs.
Cash ISAs can be a great way to protect some emergency cash or short-term savings. And for folks who really don’t want any stock market risk at all, the guaranteed returns offer a safer option. But over the long term, Stocks and Shares ISAs have wiped the floor with the Cash ISA alternative.
The top Cash ISA interest rates are currently a bit above 4%. And that’s actually not bad at all. But over the past 10 years, the average annual Stocks and Shares ISA return has come in at a whopping 9.6%.
The difference it can make
The total sum we’d need to build up depends on the rate of return we can achieve.
From that 9.6% Stocks and Shares ISA return, around £132,000 should generate enough passive income to cover our target £1,000 per month. And investing £500 per month with all dividends reinvested, we could get there in 12 years.
To get the same from a 4% Cash ISA return, we’d need more than £320,000. And at that interest rate, it should take 29 years to build that up.
To be fair, that 9.6% from shares has been above average for shares in general. But the 4% from cash can’t be maintained when Bank of England (BoE) rates come down. I can easily see Cash ISA interest getting down below the BoE’s 2% inflation target. To take home £1,000 per month from a 2% return, we’d need more than £600,000 — and 56 years to get there.
A stock to consider
Legal & General (LSE: LGEN) has a forecast dividend yield of 7.9% right now. And that alone, providing we buy new shares with the dividends each year, could go a long way towards helping us achieve our passive income goals.
The dividend isn’t guaranteed, though at first-half results time the company did point out it’s paid out “over £5bn in dividends and share buybacks over three years.”
The share price is up only a modest 3.7% in five years. In fact it hasn’t moved much in a decade, after an earlier growth spell. But to me, share price growth on top of my dividends is really just a bonus.
The insurance and investment sector is a risky one. And we should expect ups and downs along with the world economy and stock market sentiment. But as part of a well-diversified long-term portfolio, Legal & General is one stock I think passive income seekers could do well to consider.
