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The Stocks and Shares ISA is a brilliant product to target a long-term passive income. With a £20k maximum annual contribution limit, and shelter from capital gains tax and dividend tax, they can be ideal products to consider for the vast majority of UK share investors.
Also, unlike the Self-Invested Personal Pension (SIPP), there are no rules on when users can start drawing down from an ISA. This opens up the possibility, then, of a super-early retirement for some.
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.
Compounding for wealth
Obviously, the earlier an individual gets started on their investing journey, the better the chances are of generating long-term wealth. That’s because of compounding—the process where investment gains themselves begin to generate their own gains.
In short, the longer one’s money is invested, the more pronounced the eventual returns become. Here’s how a £5,000 ISA could grow over a quarter of a century, based on an average annual return of 9% a year:
| Year | Starting amount | Accrued interest | Total return |
|---|---|---|---|
| 1 | £5,000 | £450 | £5,450 |
| 5 | – | £2,693.12 | £7,693.12 |
| 10 | – | £6,836.82 | £11,836.82 |
| 15 | – | £13,212.41 | £18,212.41 |
| 20 | – | £23,022.05 | £28,022.05 |
| 25 | – | £38,115.40 | £43,115.40 |
As you can see, our investor could end up with more than £38,000 in gains — more than seven times their original investment — without adding a single penny more.
Even so, this is unlikely to prove anywhere near enough what an ISA investor will need to take a luxurious early retirement. If invested in 6%-yielding shares, a rough £43,115 portfolio would throw off just £2,586.90 a year in passive income.
A £500k+ ISA
This is why regular additional investment is so important. If our ISA user can top up with another £500 each month, they could have a supersized portfolio worth £572,284.25 after 25 years.
That’s a pretty realistic target in my view. It’s actually slightly below the £514 that the average Brit invests each month, according to Shepherds Friendly.
With a Stocks and Shares ISA of this size, our investor could have an annual passive income of more than £40,000 — £40,059.90, to be exact — if invested in 7%-yielding dividend shares.
Trust exercise
Investment trusts like F&C Investment Trust (LSE:FCIT) can be excellent choices to consider for crafting a diversified and high-performance portfolio. This particular FTSE 100 one — which has been delivering strong returns since 1868 — has produced an average annual return of 11.3% over the past decade.
That’s better than the 9% needed to create our £40k second income-generating ISA portfolio.
F&C invests in roughly 350 companies, providing strength through exposure to dozens of companies (35 in all) and industries. I particularly like its substantial holding in technology stocks like Nvidia and Microsoft. Sure, this can leave it more vulnerable to economic downturns. But it also provides significant long-term growth potential as themes like artificial intelligence (AI) and cloud computing take off.
Our £40k passive income calculation is just an example, of course. But with a diversified portfolio of UK and overseas shares, I think it’s a realistic target. Heck, the large number of Brits living off supersized ISAs proves how regular investing can create significant wealth.
This story originally appeared on Motley Fool
