Turning a Stocks and Shares ISA into a £40,000 annual passive income generator

Charlie Carman explains how he’d approach replacing an entire salary with tax-free dividend income from a Stocks and Shares ISA.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Young mixed-race woman jumping for joy in a park with confetti falling around her

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Can I earn enough tax-free passive income every year to secure financial independence? Like many investors, I’m aiming for this goal. I believe it’s possible by investing in a carefully selected portfolio in a Stocks and Shares ISA.

This tax year, I have a £20,000 limit that I can contribute to my ISA. With a long investment horizon stretching decades into the future, I could harness the power of compound returns to build a mammoth dividend portfolio.

So, here’s how I’d target £40,000 in annual passive income if I started investing today.

Should you invest £1,000 in TRIG right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if TRIG made the list?

See the 6 stocks

Diversification

As I’m at an early stage in my journey, I’d invest in a mix of growth and dividend shares.

Growth stocks would provide me with exposure to companies that are expected to boost their earnings at a faster rate than the market average.

By contrast, income-producing companies tend to have a greater focus on delivering steady returns and regular dividend payments.

The logic behind my decision to invest in both is diversification. I’d gain exposure to separate areas of the stock market that can respond in different ways to macroeconomic conditions.

Growth stocks

One FTSE 100 company I own shares of is Scottish Mortgage Investment Trust, a fund that focuses on some of the most innovative companies around the globe.

Recent returns have been disappointing, which shows the potential pitfalls of growth stock investing. Nonetheless, the trust has a long history of beating the market in bygone years.

I hope that when the economic environment improves, the Scottish Mortgage share price will appreciate at a faster rate than FTSE All-World Index that the company uses as a benchmark.

Dividend stocks

Further down the line, I’d boost my concentration in dividend shares. That’s because these firms often have robust balance sheets and long track records of profitability.

Accordingly, by owning a greater number of dividend stocks, I’d aim to reduce my volatility risk as I approach retirement. In addition, this means I may not have to sell my shares to live comfortably from my portfolio’s returns, thanks to the regular passive income streams they provide.

Dividends aren’t guaranteed. However, by spreading my investments across a range of sectors, I hope I could rely on shareholder payouts from at least some of my holdings if any single company axed or suspended its dividend.

Currently, I own various FTSE 100 dividend shares in different industries. These include tobacco, pharmaceuticals, banking, mining, housebuilding, and groceries.

FTSE 100 stockDividend yield
British American Tobacco 8.0%
GSK5.4%
Lloyds5.2%
Rio Tinto8.2%
Taylor Wimpey7.4%
Tesco3.9%

Time is my friend

Because dividend income and capital gains inside a Stocks and Shares ISA are awarded tax-free treatment, I’d reinvest my dividends within the ISA wrapper.

Let’s assume the £20k annual allowance remains unchanged. If I secured a 7.5% compound annual growth rate on my investments, it would take me 20 years to build a £1m+ portfolio by maximising my contributions every year.

At a 4% dividend yield, I’d earn £40,000 in annual passive income after just two decades!

Of course, my stocks could underperform. That would delay my progress or even send it into reverse. But, with time on my side, I could eventually earn tax-free income for life.

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.

Should you invest £1,000 in TRIG right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.

And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if TRIG made the list?

See the 6 stocks

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Charlie Carman has positions in British American Tobacco P.l.c., GSK, Lloyds Banking Group Plc, Rio Tinto Plc, Scottish Mortgage Investment Trust, Taylor Wimpey Plc, and Tesco Plc. The Motley Fool UK has recommended British American Tobacco P.l.c., GSK, Lloyds Banking Group Plc, and Tesco Plc. 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.

Our best passive income stock ideas

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

More on Investing Articles

Fans of Warren Buffett taking his photo
Investing Articles

With value investing back in vogue, I’m taking a leaf out of Warren Buffett’s playbook

With tariffs and trade wars resulting in heightened market volatility, Andrew Mackie takes comfort in Warren Buffett’s words of wisdom.

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

Around a 1-year high, is there enough value left in Next’s share price to make it worth me buying?

Next’s share price has risen a lot in eight months, but there could still be a lot of value left…

Read more »

Group of young friends toasting each other with beers in a pub
Investing Articles

OMG DYOR but IMO this ‘cool’ FTSE 100 stock offers bangin’ VFM!

Despite being one of the least trendy 50-somethings around, our writer considers how Gen Z could help push this FTSE…

Read more »

Investing Articles

2 cheap FTSE 100 and FTSE 250 growth stocks to consider as stock markets sink

I think these Footsie and FTSE 250 growth shares could be very shrewd buys to consider in the current climate.…

Read more »

Investing Articles

3 shares I’ve bought in the 2025 stock market sell-off

The stock market has experienced a lot of turbulence in recent weeks. Edward Sheldon has been taking advantage and buying…

Read more »

Investing Articles

Investors considering HSBC shares could aim for £8,453 a year in passive income from just £5 a day!

A relatively small daily investment in HSBC shares over several years can produce an extraordinary level of annual passive income…

Read more »

Investing Articles

The Rolls-Royce share price has fallen! Is this the moment investors have been waiting for?

Even the Rolls-Royce share price can't escape current stock market volatility, falling slightly over the last week. Should investors consider…

Read more »

Modern suburban family houses with car on driveway
Investing Articles

Down 59% from its 12-month highs, is this FTSE 250 stock too cheap to ignore?

Shares in FTSE 250 housebuilder Vistry are almost certainly too cheap to ignore. But are they discounted enough to offset…

Read more »