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A stocks and shares allocation ISA is a brilliant way to build up a lot of money for retirement. And it's an even better method of generating passive income to fund our later years.
Money invested within the tax-free allowance accumulates free of all capital gains tax (CGT) and income tax.
That means we don't have to pay a cent in CGT to HMRC when our stock picks rise in value. Even better, we can reinvest all dividends received from the company directly into the portfolio without paying a single cent of taxes on them.
<h2 class="wp-block-heading" id="h-ftse-100-shares-are-top-income-stocks“>FTSE 100 stocks are top income stocks
When an investor retires, they can receive one-time lump sums or regular dividends completely tax-free. This facilitates the management of general tax liability. By juggling pension and ISA withdrawals, an investor can avoid being pushed into a higher tax bracket. These tax benefits last a lifetime.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
Let's say an investor's target retirement income is £40,000 a year. If they receive £12,000 from the state pension and another £12,000 from a company pension, they would still be £16,000 short. So how much would they need in a stocks and Shares ISA to generate that?
The answer depends in part on the type of stock you buy. Let's say they start with FTSE 100 bank HSBC Holdings (LSE: HSBA).
Today, the bank has a dividend yield of 5.99%. This is a brilliant earnings rate, comfortably above the FTSE 100 average of 3.5%. Although dividends are not guaranteed, companies must generate enough profits to fund them.
In fact, HSBC has been on my shopping list for months. The Asia-focused bank appears to be a fantastic value, trading at just 8.9 times trailing earnings. That's cheap for a bank that grew profits 10% to $8.5 billion in the third quarter, beating analysts' expectations of $7.6 billion.
The board has been further rewarding shareholders to the tune of $3 billion per quarter, in the form of share buybacks.
No action is without risks. New CEO Georges Elhedery has to navigate tensions between the United States and China, manage the planned split between its eastern and western divisions and sustain growth as falling interest rates squeeze margins. However, I still really want to buy.
HSBC share price could also rise
Investing in a dozen different FTSE 100 shares would spread the risk. If an average 6% return could be generated from those shares, an investor would need £266,667 in their stocks and Shares ISA to generate £16,000 a year.
It seems like a difficult task, but it is doable, given time. With £300 invested each month and an average total return of 8% per year, it would take just under 25 years. If that monthly sum is increased each year to keep pace with inflation, the goal could be reached sooner.
Better yet, dividend income should increase over time, as most companies aim to increase their shareholders' earnings each year if they can. There are no guarantees. A portfolio may earn or earn less than expected. But having a goal to aim for is a great start.