Most of us dream of ditching work sooner and taking early retirement with a large passive income. It’s a brilliant thought, and one that may be easier to reach than you think.
Investing in a Stocks and Shares ISA saves investors a fortune in tax, and it’s tailored to capture the long-term power of the stock market. With more than 5,000 ISA millionaires in the UK, the enormous benefits are there for all to see.
But you don’t need to build a million-pound portfolio to retire early. How large does an ISA need to be to make this reality? And how can investors go about acheving it?
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.
Income target
The size of the portfolio needed will differ from person to person. No two peoples’ financial circumstances are the same. Nor are their plans for retirement. But it’s important to have a ball park figure in mind to aim for, and the one I use is that provided by Pensions UK.
Their research suggests the average Brit needs £43,900 annual income to retire comfortably. That’s on the basis of a one-person household. The figure for a two-person household is £60,600, suggesting a smaller individual nest egg may be required.
However, I think the higher figure could be the better one to aim for, regardless of one’s living arrangements. That way, you can have an extra buffer against rising costs and any unexpected expenses.
Now onto the maths…
For an individual passive income of £43,900, someone would need a Stocks and Shares ISA of just over £627,000. That’s assuming they rotated their capital into dividend shares with an average yield of 7%.
What should ISA investors buy?
There are multiple ways to turn an ISA into a regular income. I like the dividend stocks idea, because it can deliver a steady stream of cash and further portfolio growth over time. Dividends aren’t guaranteed, which is an obvious drawback, but retirees can target a reliable income with a wide selection of shares, trusts, and funds.
Investment trusts like Henderson High Income Trust (LSE:HHI) can be brilliant ‘cheat codes’ for achieving large and reliable dividends. The reason? Their holdings often span a huge range of regions and industries, reducing the risk of dividend shocks on overall returns.
This trust holds shares in 57 heavyweight UK dividend shares including Rio Tinto, National Grid, HSBC, and Unilever. We’re talking firms with strong balance sheets, leading positions in mature markets, and diverse revenue streams. It’s a formula that’s delivered unbroken dividend growth for 13 years.
By focusing on British shares, it’s vulnerable to falling interest in London stock market companies more generally. But on the whole it’s a great trust to consider, in my view. For this year its dividend yield is a generous 5.7%.
Hitting our £627k goal
With our ISA target of £627,000 now drawn up, how long could it take to achieve this? Based on an average stock market return of 9% a year, it would take 22 years and 10 months based on an £700 monthly investment.
That would allow a 40-year-old to retire years before their State Pension age of 68.
