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The Stocks and Shares ISA is an excellent way to target a large second income in retirement. Holding shares in one of these tax-efficient vehicles can save investors a fortune in capital gains tax and dividend tax.
These savings can be used for further investing, speeding up the compounding effect and helping investors build wealth more quickly. What’s more, retirees can draw down money without having to pay a penny to HMRC in income tax.
Finally, with a generous £20,000 annual contribution allowance, investors have plenty of scope to grow their portfolios. Only about 7% of Cash ISA and Stocks and Shares ISA holders use their whole yearly allocation.
The question is, much does one need in one of these products to target a healthy passive income for retirement?
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.
A £35k income target
There’s no ones-size-fits-all answer to this. Each of us has different financial circumstances and aspirations. What might be a lavish amount for some might seem pretty modest for others.
That said, I think a £35,000 ISA income is a reasonable sum to aim for. Combined with the State Pension, that could — 30 years from now — provide a total annual income of just over £60,000.
That’s based on the current full pension of £11,973 growing at 2.5% each year — the minimum annual growth rate under the so-called Triple Lock system.*
To generate that £35,000 income from a Stocks and Shares ISA, an investor would need a retirement fund of £875,000. That’s assuming a 4% annual drawdown rate that could provide a reliable income for life.
* The Triple Lock guarantees that the State Pension grows by the rate of earnings growth, consumer price inflation (CPI), or 2.5%, whichever is highest.
Investing wisely
An £875,000 portfolio is clearly a lot of cash. To make this, an investor needs to have a sound investment strategy and commitment to making regular contributions.
But an ISA of this size is very possible, in my view. The tax breaks and the impact of compounding that I’ve described make it easier to grow wealth over time. Then there’s the powerful long-term returns that global stock investing tends to deliver.
Over recent decades, stock market investors have enjoyed an average annual return of about 8% to 10%. I feel a diversified portfolio, to spread risk and capture a range of growth and income opportunities, is critical to reaching this target.
This can be achieved by buying individual shares, or investment trusts or funds that holds baskets of different equities. Many investors (myself included) do both. One fund that I currently hold is the Xtrackers World Momentum ETF (LSE:XDEM), which has positions in roughly 350 different companies.
The fund focuses on large- and mid-cap stocks with high growth potential and strong price momentum. It’s a strategy that’s paid off handsomely — since October 2015, the ETF’s delivered an average annual return of 13.7%. This is thanks in part to its large portfolio of quality US shares like Nvidia, Visa, Palantir, and Broadcom.
It’s true that a 60% weighting of Wall Street equities creates more concentration risk than more globally diverse funds. But as we’ve seen, it can also unlock stunning gains thanks to the enduring power of the US stock market.
This story originally appeared on Motley Fool
