Turning a £20k ISA into a second income of £1,000 a month!

Fancy earning a second income with minimal effort? I certainly do.

But is it possible to generate a four-figure dividend haul every month from just one year of maximum contributions to a Stocks and Shares ISA?

Yes, I believe so. Here’s how.

The journey to a £20k ISA

Every tax year each UK investor has a £20,000 annual limit they can invest in an ISA. Using this investment vehicle ensures returns are awarded tax-free treatment, whether from capital gains or dividends.

If I was lucky enough to receive a chunky inheritance, I’d put £20k straight in my ISA. That’s because lump-sum investing often beats continuously drip-feeding small amounts into assets over a long period (sometimes referred to as pound cost averaging).

There are risks to this strategy. A stock market crash soon after my initial investment could decimate the value of my portfolio. But if history is a useful guide, I also stand a good chance of making solid returns as share prices have enjoyed an upward trend over the years — at least for leading indexes like the FTSE 100 and the S&P 500.

Of course, it’s not necessary to invest all at once. I could spread several smaller contributions over years to reach my £20k goal. And once I’ve achieved that landmark, I might not need to make any additional contributions to secure a £1,000 monthly dividend yield from my investments. But I will need time.

Compound returns

Taking a £20k ISA as my starting point, I’d pursue a dividend reinvestment strategy to benefit from the power of compound returns. If I aimed for an average 4% yield across my diversified mix of dividend stocks, I’d need a portfolio worth £300k to bag £12k in annual passive income.

There are plenty of dividend shares I could choose to invest in. At present, I own a variety of income stocks across a range of sectors, including mining, fast food, and pharmaceuticals.

Examples include:

• Rio Tinto — 8.5% yield
• McDonald’s — 2.1% yield
• Johnson & Johnson — 3% yield

Adding capital gains to the equation, I’d incorporate an 8% compound annual growth rate into my assumptions. If my portfolio achieved this rate of return, it would take me a little over 35 years to achieve my target value.

So with a £20k ISA by the age of 29, in theory I wouldn’t need to make any further contributions to secure a portfolio that could yield £1,000 in monthly dividends in time for my 65th birthday.

Earning a second income

This strategy isn’t risk-free. If my assumptions are incorrect and my portfolio underperformed, I’d need to make additional investments, or wait longer to earn my coveted four-figure dividend yield.

Bear markets or poor stock picks are risks I need to consider, both of which could derail my neat calculations. There’s also a risk that the companies I own could cancel or cut their dividend pay-outs, which would also deal a blow to my passive income aspirations.

Nonetheless, the numbers I’ve picked aren’t outlandish in the context of the stock market’s historical performance. Although past performance doesn’t guarantee future returns, earning £1,000 a month from a £20k ISA is a realistic goal. So it’s time to buy some dividend stocks!

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.