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A stocks and shares ISA is a brilliant way to generate passive income, because it's tax-free.
I'm only in the first month of the new financial year and I haven't yet started investing up to my £20,000 limit. So I'm looking at the FTSE 100looking for stocks that should generate the highest possible second income.
Not all companies pay dividends, but most large companies do. In fact, FTSE 100 stocks pay some of the most generous dividends in the world. While the index has a total return of around 3.7%, individual stocks can pay up to 7%, 8%, 9% and, in one or two cases, even more than that.
Chasing performance
One of my favorites is an insurer and asset manager. Legal and General Group (LSE: LGEN). I admit, L&G's share price performance is not the best. It is down 12.91% in five years and up only 4.02% in the last 12 months.
However, what it has lacked in recent capital growth is made up for by dividend income. Which, he reminds him, will be tax-free in an ISA.
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.
L&G is forecast to earn a yield of 8.88% in 2024. And since most companies aim to increase their dividends over time, it is forecast to reach 9.37% in 2025. Which is a Incredible income, almost double that of the best cash accounts.
Unlike savings rates, dividends are never guaranteed. Once returns approach double digits, payouts to shareholders may be vulnerable. Personally, I don't expect L&G to cut dividends, but no one knows for sure.
I think the investment case is strong. L&G specializes in selling retirement products and demand should grow with the aging population. Especially since it is clear that the State cannot guarantee a comfortable retirement. However, it is operating in a competitive market. And investors seem discouraged by financial stocks in general.
I plan to retire with my dividends
I expected Legal & General's share price to rise this year, but it has been held back by the growing realization that interest rates will stay high for longer. That boosts returns on lower-risk asset classes, such as cash and bonds. However, I think that when inflation and interest rates fall, the L&G share price could come to life. Priced at 10.7 times forward 2024 earnings, it certainly appears to be a good value.
If I could earn 8.8% a year on my £20,000 ISA allowance, I would have an income of £1,760 a year. However, that's a bit ambitious. Ideally I would spread my ISA across five FTSE 100 income stocks, with different levels of risk.
Some perform even more than L&G, such as the insurer Phoenix group holdings, which pays an income of 10.13%. Others pay less, for example the builder. Taylor Wimpey yields 6.88%.
My goal is an average return of 8% per year. That would give me a solid £1,600 in the first year, plus any share price growth. Hopefully, that amount would increase over time and generate the passive income I need to fund my retirement. It's time for me to start populating my ISA.
