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Although the Isa is a good place to grow a nest egg, used wisely, it can also be used to generate tax-free income to supplement a salary or pension.
This can be done by withdrawing the interest you earn on a cash Isa and using it as regular income.
But to improve your chances of generating a higher income in the long term, stocks and shares Isas are a good bet. These allow you to invest in funds, investment trusts and shares of individual companies.
The key is to focus on investments that aim to provide regular income in the form of dividends.
Some people also invest in assets that they believe have high growth potential and make a profit from time to time as a form of income.
Tax-free income: You can use an Isa to supplement a salary or pension by withdrawing the interest you earn on a cash Isa and using it as regular income.
Funds and investment trusts that pay income usually do so quarterly, but some pay monthly, semi-annually or annually.
Here, experts reveal how to set up your investments so you can grow your income and receive a tax-free income of £10,000 every year.
Build up a reliable income
Generating a substantial income from your Isa doesn’t happen overnight. But thanks to the powers of compound interest, it may take less time than you think.
You would need around £225,000 in your Isa to get a tax-free income of £10,000 a year, according to calculations by investment platform Interactive Investor.
If your investments grew by 5% per year, you would need to invest £1,450 per month, or £17,400 per year, over ten years.
If you were able to pay the full £20,000 Isa allowance, you could accumulate £225,000 in seven and a half years (assuming you make no further withdrawals).
Choose your funds wisely
To decide whether a fund is a good choice for generating income, you need to look at its yield, which is how much cash it pays out relative to the cost of the fund.
For a £225,000 Isa pot to produce £10,000 of income a year, you’ll need to aim for a 4.55% return for your entire portfolio.
Murray Investment Trust, which has a dividend yield of 4.66 percent, is an income investment choice nominated by Philippa Maffioli at Blyth-Richmond Investment Managers.
She says the trust, which owns analytics group RELX and drugmaker AstraZeneca, among others, is trading at an 11% discount, meaning it is cheap compared to its current price and offers prospects. growth as well as income.
Artemis Income, with a yield of just over 4 per cent, is a good choice according to Kate Marshall, investment analyst at Hargreaves Lansdown. This is a UK-focused fund, with RELX and venture capital 3i among its main holdings.
Rob Burgeman, of wealth manager Brewin Dolphin, names the Merchants Trust, with a return of more than 5 per cent.
It is one of 20 trusts that has increased its dividend every year for 20 years and counts pharmaceutical group GSK and oil and gas company Shell among its top holdings.
When building an income-focused portfolio, it’s worth investing in a range of assets to spread risk.
It may be tempting to simply select a few companies that have produced the highest returns in the past, but there is no guarantee that they will continue to achieve similar performance.
Opt for assets that you believe have a high chance of producing a good income, now and in the future.
Interest: You would need around £225,000 in your Isa to get a tax-free income of £10,000 a year, according to calculations by investment platform Interactive Investor.
Beware of “Inc” Funds
Funds tend to come in two versions: “Acc” or “Inc”. You will see these abbreviations written after the name of a fund in your portfolio or on investment platforms.
“Acc” is the abbreviation of “Accumulation” and “Inc” is the abbreviation of “Income”. If you want your fund’s performance to be paid to you as income, opt for the Inc version of the fund. If you want the income to be reinvested to buy more of the same fund, go for Acc.
An accumulation fund is best for building your portfolio, but an income fund will give you money ready to spend if you choose.
“My Isa pays all my bills”
Michael Taylor, 33, uses his Isa allowance to provide tax-free income. The writer and consultant, originally from London, uses his entire annual allocation to build a portfolio of individual company stocks.
He has amassed a seven-figure sum and now has enough money to regularly withdraw money tax-free.
Michael, who says he can now spend more time with his wife Nora and one-year-old son Linus, says: “I used to work in an office, which I didn’t like very much. Even though I now work on weekends, I have more freedom.
Michael’s strategy, which he talks about on his blog Shifting Shares.com, involves trading with small UK businesses.
He acknowledges it’s risky and not for everyone, but says no matter how you invest, using your Isa allowance is useful to ensure all your income is tax-free.
Check out the best Cash Isa rates in our savings tables
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