The annual deadline for contributing up to the £20,000 Stocks and Shares ISA limit is just over a month away on 5 April, so there’s no time to lose. It’s a brilliant way to build wealth from equities and create a tax-free second income for retirement. But where to start?
All share price growth and every dividend are free of tax for life within the wrapper. The pot can even be passed on to a spouse or civil partner on death.
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.
The best way to invest is to start as early as possible and keep going to retirement (and ideally beyond). That way, even modest regular contributions have time to compound into substantial sums. Reinvesting every dividend automatically buys more shares and turbocharges growth over time.
Build wealth with FTSE 100 shares
Now, let’s say somebody has £40,000 in their ISA today. That’s not life-changing, but it’s not peanuts either. So how much income might that generate by 2040?
Assume our investor spreads the money across FTSE 100 stocks and achieves an average annual return of 7%. A lot of the time, markets will beat that. Occasionally, markets will end the year lower, although with luck the dividends will keep flowing. Short-term volatility is the price investors pay for the long-term wealth-generating power of equities.
Fourteen years isn’t a huge amount of time when it comes to investing. But at 7% a year, £40,000 would still grow to £103,141. That’s a chunky £63,141 in tax-free profit. Leave £40,000 invested for 40 years under the same assumptions and it could grow to a massive £598,978.
Returning to the £103,141 figure. If the portfolio yielded 5% a year by 2040, it would generate £5,157 of annual income. That’s a useful boost in retirement, but it’s not transformational.
However, if the same investor started with £40,000 and then used their full £20,000 ISA ‘allowance’ every year for the next 14 years, they’d build a pot worth £585,722, assuming the same 7% return. With a 5% yield, that would produce £29,286 a year in income without touching the capital. Now that really would change retirement.
Lloyds is a top income growth stock
Investors may be able to beat 7% by selecting individual shares. Lloyds Banking Group (LSE: LLOY) is one of my favourite holdings. The shares have had a strong run, rising 46% over one year and 130% over two, with dividends on top.
As a result, the trailing yield has slipped to around 3.5%, but that should rise over time. The board has been increasing shareholder payouts at roughly 15% a year, comfortably ahead of inflation. Like any stock, it carries risks. Lloyds is heavily exposed to the UK economy, which is pretty sluggish. Falling interest rates could squeeze net interest margins, the gap between what it charges borrowers and pays savers.
However, over a 14-year horizon, and ideally a much longer one, I think it can still deliver a solid total return and is well worth considering. Treat it as one building block in a balanced portfolio of perhaps 15 shares. There are plenty of other opportunities on the FTSE 100, so don’t hang around. It’s ISA time!
