Image source: Getty Images
The ability to invest up to £20,000 per year in an ISA and not pay a penny tax on the passive income it can generate can be life-changing.
In the 2023/24 financial year, the latest for which we have the numbers, UK adults held 15m ISA accounts. And the total cash invested in those ISA accounts came to £103bn! So we’re a nation of canny savers and investors, right? Well, we need to dig a bit deeper.
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.
Pick the right one
Of those 15m ISA accounts, 9.9m were Cash ISAs — and only 4.1m were Stocks and Shares ISAs. Cash ISAs held £69.5bn, but only £31.1bn — less than half that amount — went into Stocks and Shares ISAs.
Cash ISAs can be a great way to protect some emergency cash or short-term savings. And for folks who really don’t want any stock market risk at all, the guaranteed returns offer a safer option. But over the long term, Stocks and Shares ISAs have wiped the floor with the Cash ISA alternative.
The top Cash ISA interest rates are currently a bit above 4%. And that’s actually not bad at all. But over the past 10 years, the average annual Stocks and Shares ISA return has come in at a whopping 9.6%.
The difference it can make
The total sum we’d need to build up depends on the rate of return we can achieve.
From that 9.6% Stocks and Shares ISA return, around £132,000 should generate enough passive income to cover our target £1,000 per month. And investing £500 per month with all dividends reinvested, we could get there in 12 years.
To get the same from a 4% Cash ISA return, we’d need more than £320,000. And at that interest rate, it should take 29 years to build that up.
To be fair, that 9.6% from shares has been above average for shares in general. But the 4% from cash can’t be maintained when Bank of England (BoE) rates come down. I can easily see Cash ISA interest getting down below the BoE’s 2% inflation target. To take home £1,000 per month from a 2% return, we’d need more than £600,000 — and 56 years to get there.
A stock to consider
Legal & General (LSE: LGEN) has a forecast dividend yield of 7.9% right now. And that alone, providing we buy new shares with the dividends each year, could go a long way towards helping us achieve our passive income goals.
The dividend isn’t guaranteed, though at first-half results time the company did point out it’s paid out “over £5bn in dividends and share buybacks over three years.”
The share price is up only a modest 3.7% in five years. In fact it hasn’t moved much in a decade, after an earlier growth spell. But to me, share price growth on top of my dividends is really just a bonus.
The insurance and investment sector is a risky one. And we should expect ups and downs along with the world economy and stock market sentiment. But as part of a well-diversified long-term portfolio, Legal & General is one stock I think passive income seekers could do well to consider.
