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Ever dreamed of making a substantial passive income free of tax? With the Individual Savings Account (ISA), Brits have a ready-made vehicle to make that vision a reality.
A generous £20,000 annual allowance means the Cash ISA and Stocks and Shares ISA give savers and investors significant headroom to grow their wealth. That said, with compounding and the stock market’s long-term returns factored in, investing ISA is the best way for me to target a large second income.
Let’s say I want to achieve an income of £700 each month on top of what I earn at work. How much will I need to have in one of these tax-efficient products?
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.
What’s the best ISA?
The problem with a Stocks and Shares ISA is that they don’t offer a guaranteed return. In fact, unlike a Cash ISA, an investor can actually lose money, reflecting the fact stock markets fall as well as rise.
So why prioritise stock investing over holding cash? A look at the long-term returns on both these products make it (in my view) a no-brainer decision.
According to Moneyfacts, the Stocks and Shares ISA has delivered an average annual return of 6.79% since 2010. The return on the Cash ISA, meanwhile, sits way back at 1.79%. It means those who took the ‘easy’ option would likely have far, far less money in their wallet today.
A £700 monthly passive income works out at £8,400 a year. To generate that, I would need a nest egg of £210,000.
Based on that 1.79% return of the Cash ISA, I’d need to wait 27 years and three months to hit that magic number. That’s based on an investment of £500 a month.
With a Stocks and Shares ISA and dividends reinvested, the timeframe falls to exactly 18 years. The power of that 6.79% would shave almost a decade off the time I’d need to reach that £210k goal.
A stock I’ve just bought
Past performance isn’t a guarantee of future returns. But with interest rates on savings accounts falling again, I’m confident the enormous difference in returns between these ISAs will continue.
As I say, stock market investing is more volatile. But I can reduce this by building a diversified portfolio of companies. My own portfolio consists of more than 20 stocks, trusts, and funds. Aviva (LSE:AV.) is a share I’ve just bought more of recently.
I mainly bought the FTSE 100 company for its enormous dividend potential. Annual payouts have risen a solid 7% over the last 10 years. Thanks to Aviva’s cash-rich balance sheet, City analysts expect dividends to keep growing, resulting in enormous 6.4% and 6.9% yields for 2026 and 2027.
That’s not to say Aviva’s a one-trick pony, though: indeed, it’s also one of the Footsie’s most attractive growth shares in my view. Earnings are expected to rise another 10% this year and 11% in 2027, as CEO Amanda Blanc’s restructuring drive continues and the broader financial services market steadily grows.
Are Aviva shares totally risk free? Absolutely not, as the competitive and regulatory pressures are severe. But it’s provided excellent returns in years gone by, and I’m confident it will continue to power my Stocks and Shares ISA.
