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A Stocks and Shares ISA is one of the most effective ways I know to generate passive income for retirement. The tax benefits are hard to beat, since all dividends and capital gains are sheltered from HMRC. Unlike pensions, there’s no tax on withdrawals either, making it a flexible long-term wealth builder.
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 the target pot
A retirement income of £2,000 a month would adds up to £24,000 a year. And remember, that’s tax free in an ISA. Using the 4% withdrawal rule, which assumes investors can safely take 4% of their pot each year without depleting it, that requires £600,000 invested.
That’s a sizeable sum, but it’s not out of reach. If someone invested £500 a month in a diversified portfolio of shares that delivered average annual growth of 7%, they’d have around £612,000 after 30 years. Even smaller contributions would add up nicely, thanks to the miracle of compound returns.
Reinvesting every dividend along the way can help the portfolio grow much faster, since each payout buys more shares that then throw off further dividends.
Lloyds offers dividends and growth
Lloyds Banking Group (LSE: LLOY) has finally escaped from the shadow of the financial crisis. Its share price has risen 40% over the past year and 240% over five years.
Even after that surge, it trades on a modest price-to-earnings ratio of 13. However, that’s a little higher than FTSE 100 rivals Barclays or NatWest, which sit closer to 10. Investors should check out those, or even hold two or three to spread risk.
On 24 July, Lloyds reported a 5% rise in first-half pre-tax profits to £3.5bn, supported by strong lending and deposit growth. The board backed its full-year guidance and hiked the interim dividend 15% to 1.22p per share. That pushed the forward yield to 4.32%, with forecasts suggesting it could climb to 5% by 2026.
For those aiming to build a reliable income stream, that’s encouraging. It shows management is committed to rewarding investors directly through dividends. There are risks, though. Falling interest rates will squeeze margins, and any economic slowdown could drive up bad loans. The looming autumn Budget may also include fresh tax grabs on banks, which would hit profits.
Keeping perspective
No single share is guaranteed to perform, especially in the banking sector. The motor finance mis-selling saga still hangs over Lloyds, even if early fears of a compensation bonanza have eased. After such a strong run, I suspect the share price could cool. But with more dividend growth likely, I still think long-term investors might consider buying today.
I wouldn’t rely on one stock alone. My preference is to hold at least 15 to 20 across different industries, offering both share price growth and dividend potential. September and October can be a volatile time for stock markets, but investors should stay invested through the swings, and even take any advantage of any dips to buy more shares.
Building a £600,000 portfolio isn’t an overnight job but with patience, regular investing and the tax-free power of ISAs, generating £2,000 a month in retirement income can be done. Investors’ secret weapon is time. Don’t waste it.
This story originally appeared on Motley Fool
