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UK shares pay some of the most generous dividends in the world which makes them a terrific way to build a second income stream for retirement. If held inside a Stocks and Shares ISA, investors get all of that income free of tax, and capital gains are tax-free too. So how how much do investors need to tuck away?
Let’s say someone wants a passive income of £2,000 a month in retirement from their ISA. One widely used yardstick is the 4% rule. This suggests that investors can withdraw that percentage of their pot each year, without dipping into the capital. Apply that here and the required ISA pot comes out at £600,000. That’s a chunky sum, but it gives a clear target to aim for.
Turning dividends into cashflow
I think income investors can do better than 4% by focusing on dividend-paying shares. A diversified spread of higher-yielding FTSE 100 and FTSE 250 stocks could potentially generate around 5.5% a year. At that level, the income target drops sharply, with £24,000 requiring roughly £435,000 instead.
Building that sort of pot takes patience rather than investment heroics. Let’s take the case of someone starting at 30 with £20,000 already invested. If they pay in another £200 a month, and their investments deliver a total average return of 7% a year, they’d have £656,000 by age 67.
Lloyds shares offer growth and dividends
One share worth considering for both dividend income and share price growth is Lloyds Banking Group (LSE: LLOY). After years in the doldrums following the financial crisis, the bank has rebuilt its balance sheet and reputation. The shares are up 80% over the last year, as revenues, profits and cash flows soar.
That strong run has pulled the trailing yield down to about 3.25%, yet I’m expecting that to grow over time as Lloyds is lifting shareholder payouts by roughly 15% a year. That comfortably beats inflation, which means investors don’t just get a high income, but one that’s rising every year in real terms. Forecasts suggest the yield could approach 4.2% in 2026. Just remember that dividends aren’t guaranteed.
Lloyds is more expensive than it was though. Its The price-to-earnings ratio has climbed towards 18, although it falls to a more modest 11.5 on forecast earnings.
Playing the long game
The wider UK economy still looks fragile, which could squeeze Lloyds as it’s primarily focused on the domestic market. Falling base rates could squeeze its net interest margins, hitting profits, but as the biggest mortgage lender through subsidiary Halifax, Lloyds could benefit from any revival in home lending.
The Lloyds share price is unlikely to climb at the same breakneck pace in 2026. It could even fall. However, short-term share price swings matter less than steady progress over many years. On that basis, I think Lloyds is worth considering as part of a wider income-focused portfolio.
The key is to spread money across a range of companies. Diversification smooths the bumps and keeps income flowing when one sector struggles. Start early, reinvest dividends, and stay focused on the long term. Do that, and a £2,000 monthly income from an ISA starts to feel achievable. This is a new year. Time to get stuck in.
