NEWSLETTER
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With a tax-efficient Individual Savings Account (ISA), any of us can significantly improve our chances of earning a significant second income in retirement.
This is one way a person can try to generate a passive income of £3,000 with tax-free ISAs.
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.
Think carefully
The first thing to say is that there is no plan to invest or save. We all have different short- and long-term investment goals, as well as different attitudes to risk and unique financial circumstances.
That being said, there are some strict guidelines for investing that some ignore at their own peril.
One is that saving predominantly in cash ISAs is unlikely to provide most of us with a second income for a comfortable retirement. Simply put, our money may be safe in such an account, but the returns we get are likely to be insufficient, given most people's circumstances.
Aiming for a monthly income of £3k
Let's say an investor has £514 free each month. That's the average amount Britons currently save or invest, according to financial services provider Shepherd's Friendly.
If they invested that in a cash ISA yielding 4%, after 30 years they would have £356,741 in their account. Based on a 4% annual withdrawal rate, that would give them an income of £14,270, or £1,189 a month.
As mentioned, said income is guaranteed and secure. But even with the state pension added, this person is unlikely to have the £43,100 that the Pensions and Lifetime Savings Association (PLSA) says people need to retire comfortably.
To meet this threshold, an ISA investor would need a balance of £900,000 or something like that when they retire.
Based on that same 4% withdrawal rate, this £900,000 balance would provide an average monthly income of £36,000. With the state pension added, that PLSA target of £43,100 could be quite achievable.
This could be achieved by investing in shares that provide an average annual return of 8.8% in a stocks and Shares ISA.
Invest in funds
In my opinion, that 8.8% return is achievable based on the proven long-term rates of return on UK and US stocks.
He FTSE 100 and S&P 500 They have obtained average annual returns of 7% and 11%, respectively. If this continues, which unlike a cash ISA is not guaranteed, that £514 invested equally in a tracking fund for each index would give the investor that magical second monthly income of £3,000.
He iShares Core S&P 500 ETF (LSE:CSPX) is one such fund that investors can consider today.
With an ongoing charge of 0.07%, it is the cheapest S&P-based ETF currently available in the UK. When combined with a stocks and shares ISA, it could save investors a lot of cash by eliminating unnecessary fees and taxes.
Investing in any fund is riskier than holding cash. However, by investing in 500 different companies, products like this can help investors spread risk effectively while chasing those superior returns.
In this case, individuals reduce risk with hundreds of different companies spanning many geographies and industries. This does not mean that the fund cannot decline during economic crises. But it can minimize volatility and produce smooth, solid performance over the long term.
That's why I have an S&P 500 fund in my own ISA.
