1 ISA, £20k, and 3 stocks. Is this the perfect recipe for a second income of £1,420 a year?

The principal advantage of a Stocks and Shares ISA is that it’s possible to invest £20,000 every year and earn a second income that’s tax free. And HMRC won’t be interested in any capital gains either.

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.

If I was in a position to invest, I’d pick three FTSE 100 dividend stocks to help boost my income.

According to AJ Bell, the Footsie is currently yielding 3.9%. But there are five stocks in the index that don’t pay any dividends. And there are many more that offer relatively low returns for shareholders. It’s therefore possible to beat the average.

However, I wouldn’t necessarily choose the highest-yielding shares. A very large yield could be an indication that investors think the present payout is unsustainable. Instead, I’m going to look at those stocks that pay reliable dividends.

Slow and steady

National Grid (LSE:NG.) last cut its dividend in 1996. Its monopoly status in its key electricity and gas markets means it has stable and predictable earnings. And as long as it invests enough to keep the lights on, regulators will leave it alone.

The company aims to increase its dividend each year in line with CPIH, which is inflation including housing costs. Between now and 2026, it hopes to grow earnings per share by 6%-8% per annum. With CPIH currently at 3.8% — and falling — the company should be able to comfortably meet its dividend growth target. A payout of 60p over the next 12 months appears affordable to me.

One negative is that the company has borrowed heavily to fund its infrastructure investment. But although it has a mountain of debt on its balance sheet — £44.8bn at 30 September 2023 — 79% of it carries a fixed rate of interest, giving it a high degree of certainty about its interest payments.

The downside of owning a stake in a regulated business is that its share price is unlikely to grow spectacularly. Indeed, since March 2019, it has risen by 23%. And a change of government could result in a tougher regulatory regime — and lower earnings.

But I think it’s the sort of company that’s unlikely to deliver any surprises, which makes it ideal for an income investor like me.

Other stocks

My next choice would be HSBC. Although most economists believe interest rates are currently at their peak, analysts are expecting the bank to report healthy post-tax profits over the next three years — $27.9bn (2024), $22.9bn (2025), and $22.8bn (2026).

The bank plans to return 50% to shareholders via dividends. Analysts are predicting earnings per share of $1.40 in 2024. I’d therefore expect to receive $0.70 (55.4p). This excludes a payment of $0.21 that’s due when HSBC Canada is sold.

Finally, I’d pick Taylor Wimpey. I think the green shoots of a recovery in the housing market are starting to appear. And despite the recent downturn, it’s been able to increase its dividend for the past four years. Even though analysts are expecting a 4% drop in 2024, a payment of 9.2p implies a yield of 6.5%

Dividing £20,000 equally between these three stocks could give me a second income of £1,420 a year – a current yield of 7.1%.

Of course, dividends are never guaranteed. And I’d need to do more research before committing to buying all three. But this theoretical exercise illustrates how it’s possible to generate a decent tax-free second income.