Dividends from blue-chip companies is a popular way to earn a passive income. With the right strategy, Stocks and Shares ISA users can target an extra £1k of cash each month in retirement this way.
How large would your ISA need to be to deliver this kind of second income, though?
Let’s talk dividends
This depends on what your plan is once you retire. Do you plan to purchase an annuity, or draw down a percentage of your ISA each year? Perhaps a combination of both?
Let’s keep things simple, and assume you plan to buy dividend shares with your pension pot. It’s the plan I’m expecting to take. This way, I’ll have cash to cover living costs in the form of dividends. And by not depleting my nest egg over time, I can improve my chances of growing my capital too.
A £1,000 monthly income works out at £12,000 a year. To generate that kind of cash flow, an investor’s portfolio will need to be worth:
- £240,000, if invested in 5%-yielding dividend shares
- £200,000, if put into stocks with 6% dividend yields
- £172,000, if invested in 7%-yielding stocks
- £150,000, if spent on dividend shares with 8% yields
You can clearly see that the higher the yield, the smaller the ISA needs to be. So let’s rush out and buy the largest-dividend-yielding stock out there, right? For the FTSE 100, that’s currently Legal & General (LSE:LGEN).
The forward dividend yield here is 9.2%. For a £1,000 income from Legal & General shares, a Stocks and Shares ISA would need to be worth just £131,000.
A top ISA buy?
But here’s the thing. Putting all your eggs in one basket is a highly risky strategy. If the company you’re invested in hits trouble, the dividend income can dry up, putting your living standards at risk.
I hold Legal & General shares myself for dividends. Yields have been more than double the FTSE 100 average for years, which to me was too good to ignore. The huge income I receive is reinvested to supercharge my portfolio growth.
I’m confident it will continue performing well for me in retirement. The firm’s strong balance sheet gives it scope to keep paying impressive dividends even if profits come under pressure. Its Solvency II ratio sits at 210%, more than double regulatory requirements. Looking further out, I think rapid market growth will underpin large and growing dividends each year.
Targeting a £1k monthly income
But there’s no guarantee of this, of course. What about if regulatory capital requirements change, or competitive pressures rise, putting profits under pressure?
For this reason, Legal & General’s one of roughly 20 to 25 shares I hold in my portfolio. It’s a number I plan to keep, more or less, to fund my retirement. A 7%-yielding ISA worth £172,000 will be needed for a £1,000 monthly income, as I’ve said. This could be achieved by investing roughly £250 a month over 20 years with an average annual return of 8%.
