A Stocks and Shares ISA’s an effective way to build passive income because the tax-free benefits mean more of the growth stays in your pocket. For most UK investors, that makes it more attractive than a standard dealing account or cash savings, especially if you’re aiming to live off your investments one day.
For example, say you want to bring in £750 a month. That’s equivalent to £9,000 a year, which should be withdrawn using the recommended 4% rule. The idea is that by taking out only 4% a year, you don’t rapidly deplete the overall capital.
So for that much income, you’d need a pot of around £225k (£9,000 is 4% of £225k).
Naturally, to build a pot that big takes dedication, patience, and good stock-picking skills. But how does that look in practice?
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.
Building £225k with monthly investing
Let’s say you invest £300 a month into your ISA. Working with a realistic average annual return of 8% a year, the growth could compound as such:
Within 15 years, it could exceed £100,000 and after 20 years, it would be about £171,000. In less than 25 years, you could hit the £225k target.
These are only estimates, not guarantees, but they show how regular contributions plus compounding can snowball into a serious income-producing pot over time.
So how can an investor optimise their chances of achieving those returns?
Targeting 8%+ returns
To aim for 8% or higher, I’d focus on a diversified basket of solid dividend payers mixed with a few quality growth stocks. A mix across sectors (banks, consumer stocks, healthcare, tech, infrastructure) helps to reduce the risk of concentrated losses in one area.
On the FTSE 100, some examples include HSBC, Legal & General, GSK, and National Grid. But the mid-cap FTSE 250 index shouldn’t be overlooked.
One example of a promising mid-cap income stock is challenger bank OSB Group (LSE: OSB).
A closer look at OSB Group
OSB focuses on specialist lending, such as buy-to-let and residential mortgages. It’s made impressive progress over the past decade, up 87.7% in the past 10 years. With dividends included, the total shareholder returns ramp up to 272% — an annualised return of 14% a year.
If it continued on that trajectory, it would make an excellent addition to a passive income portoflio.
Its dividend yield is 6.3%, with a payout ratio of 46%, so it’s well covered by earnings and has room to be increased if profits grow.
But with heavy exposure to the UK mortgage market, a weak economy, falling property prices, or higher borrower defaults could hit profits. If the Bank of England cuts rates and borrowers refinance at cheaper deals, it could limit future growth.
Still, management’s delivered continuous, uninterrupted dividends for 12 years, and the bank generates a return on equity (ROE) of roughly 12.6%. That’s a strong sign it’s making solid profits on shareholders’ capital.
The bottom line
For UK investors building ISA income, a stock like OSB is worth considering. The attractive yield plus potential capital growth would speed up the journey to £225k.
But the key is not to bet everything on one name. By combining several resilient dividend payers and growth stocks with a multi-decade outlook, your ISA has a better chance of reaching that goal.
