Could 1 ISA, £20,000, and 5 FTSE 100 stocks generate £12,517 of passive income a year?

Passive income is a means of generating cash from doing very little. One way in which I try to earn a second income is to invest in the UK stock market.

But in some respects, the term can be misleading. Personally, I think it’s worthwhile spending time researching which stocks to buy. Once chosen, I think that’s the best time to be passive. In other words, ignore day-to-day movements in their prices and take a long-term view. Importantly, don’t keep buying and selling (that’s trading, not investing). And have confidence that, generally speaking, quality companies should consistently deliver above-average returns over several decades.

Those in a position to add money to their Stocks and Shares ISA this year have until 5 April. The maximum amount that can be added every 12 months is £20,000. The advantage of using this particular investment vehicle is that any gains and income are tax-free.

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.

One strategy

Those with £20,000 to spare could consider investing in the FTSE 100. But I don’t think it would be sensible to put the full amount into one stock. Diversification helps spread the risk. Determining the number of shares to buy is a matter of personal preference. Some experts suggest 10-15.

Personally, I would pick a handful. But what sort of passive income could be generated from FTSE 100 stocks over a period of 40 years?

Let’s crunch some numbers.

While there’s no guarantee that history will be repeated, since February 2020, the average annual return of the FTSE 100 has been 7.4%. This assumes all dividends are reinvested, a process known as compounding.

If this rate of growth continues, a £20,000 lump-sum would grow to £347,697 after four decades. Based on the Footsie’s current dividend yield of 3.6%, this would generate annual passive income of £12,517.

Green shoots of a recovery

Those looking for a FTSE 100 stock to include in a well-balanced portfolio could consider Persimmon (LSE:PSN).

Due to a higher interest rate environment and a post-pandemic squeeze on disposable incomes, the housing market has been through a rough timely lately. Not surprisingly, the housebuilder’s share price has tanked as a result. Since March 2020, it has fallen 42%.

However, there are signs that things could be on the turn. In 2024, Persimmon built 10,664 homes, a 7% increase on 2023. For 2025, it’s forecasting 11,000-11,500.

Looking forward, an anticipated fall in interest rates should help stimulate demand. And the government has promised a series of planning reforms to help get Britain building again.

There’s also some talk that regulators have been tasked with making mortgages more accessible to first-time buyers. With a lower average selling price than it peers, this could be hugely beneficial to Persimmon.

However, there’s no guarantee that the housing market will recover, although history suggests it probably will. Of some concern, building costs are rising faster than general inflation. And the government’s decision to increase employer’s national insurance contributions has further damaged industry profitability.

But on balance, I think Persimmon’s well placed to grow over the coming years. It has no debt and plenty of land on which to build. And it’s yielding 5%. For these reasons, I think it’s a stock that investors could consider adding to their portfolios as part of a strategy to generate a healthy level of passive income.