I think a Stocks and Shares ISA is the ideal vehicle to create a passive income stream for life. These products have two qualities that are ideal for creating wealth.
For a start, I believe investing in stocks and shares is one of the easiest ways to generate a passive income stream. ISA wrappers allow me to do just that.
They are also tax-efficient. Any income or capital gains earned on investments held inside these wrappers does not attract any additional tax obligations. The only restriction is that the annual limit for these products is £20,000.
As such, I can earn a tax-free income from equities. This means if I can generate enough income from stocks and shares, I could potentially have a tax-free income stream.
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.
Passive income stream
According to my calculations, a monthly lump sum of just £200 could be enough to generate a passive income stream from my equity portfolio.
A figure of £200 a month, or £2,400 a year, could generate an annual income of £168 if I can invest this cash in shares yielding 7%.
The one risk of using this strategy is that dividend income is never guaranteed. Dividend income is paid out of corporate profits. Therefore, if company profits suddenly slump, the payout could be for the chop. This is something I will be factoring in when analysing potential income investments.
But I am not going to start investing for passive income straight away. I think it would be sensible to try and grow the value of my monthly deposit and switch to income later.
Indeed, I calculate that if I can achieve an annual return of 10% on my money, I could build a portfolio worth £41,000 after a decade.
Of course, there is no guarantee that I will earn a 10% per annum return. This is just a ballpark figure. The actual return I will make on my money could vary significantly. It may be a lot more or a lot less than this 10% estimate.
Still, I think this strategy of investing for growth and then switching the income could generate the best returns on my Stocks and Shares ISA investment.
Stocks and Shares ISA investments
When I have hit a certain level of wealth, I plan to switch from growth investing to income investing.
I believe this is the best strategy to generate a steady passive income on my money. Some of the best income investments on the market at the moment, which yield around 7%, and I will be happy to add to my portfolio, are Phoenix Group and Direct Line.
According to my figures, a portfolio of stocks yielding 7% could generate an annual passive income of nearly £3,000 on a lump sum of £41,000. Combined with the tax advantages of a Stocks and Shares ISA, I think this is a desirable potential return.
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Rupert Hargreaves owns Direct Line Insurance. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
