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Having an extra £1,000 each month as part of a retirement income can make an enormous difference. It’s enough to double the current full UK State Pension, bringing a pensioner’s total passive income to just shy of £24,000.
That’s more than sufficient to exceed the minimum living requirements, putting someone on track to enjoy a more moderate retirement – including holidays, eating out, buying gifts, as well as covering the weekly shopping. At least, that’s what the Pensions and Lifetime Savings Association has estimated.
But how much money is needed inside an ISA to generate these extra earnings tax-free?
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.
Crunching the numbers
Most easy-access Cash ISAs currently offer around 3% in interest. So if the goal is to have an extra £1,000 flowing in each month, a total of £400,000 will need to be saved up. Yet with interest rates expected to fall in the coming years, pensioners might end up needing significantly more.
However, with a Stocks and Shares ISA, the story’s a bit different. Investing opens the door to potentially far more impressive returns. On average, UK income stocks generate a dividend yield close to 4%. This already reduces the required portfolio size down from £400,000 to £300,000. Yet, by being more selective, it’s possible to unlock a 5% yield without taking on excessive levels of risk. And that lowers the threshold even further to £240,000.
Building a £240,000 portfolio
Not everyone’s fortunate enough to have close to a quarter of a million tucked away. In fact, the average retirement savings for 45-54 year-olds is around £80,000, according to the Office for National Statistics. But that’s more than enough to get the ball rolling.
Starting with £80,000 and injecting an extra £500 each month at the stock market’s total average return of 8% is enough to reach £240,000 in just under nine years. And once that target’s been hit, it’s just a matter of finding higher-yielding dividend stocks to generate a reliable retirement income stream. Of course, that’s far easier said than done.
Finding quality yields
Let’s take a look at British American Tobacco (LSE:BATS) as an example to consider. At a 5.8% yield, it exceeds our target. And with a 29-year track record of hiking shareholder payouts, it certainly seems to be a consistent dividend grower.
So is this a no-brainer income stock to buy in 2025? Not necessarily. Tobacco consumption’s steadily falling. Management isn’t blind to this risk, and it’s why the company has been making a big push into alternative non-combustible products like heated tobacco and vapour.
There’s still a long way to go before these products become the primary driving force of the firm’s revenue stream. But with a sturdy balance sheet and still-predictable cash flows, management seems to have the financial flexibility to execute this strategy over time.
But whether these products can evolve to match the profitability of cigarettes remains a bit of a mystery. Early data shows that vape users are far less loyal to brands by comparison. And if British American Tobacco can’t leverage its own to generate pricing power, the firm’s impressive dividend hiking streak could come to an end.
That’s why I think investors may want to look elsewhere for retirement income investing opportunities.
