With as little as £100 a month, I plan to capitalise on the compounding interest of an ISA to secure a second income stream for my future.
While a pension scheme is the most common hands-off way to save for retirement, it does come with some pitfalls. Should I wish to retire early, I’d have to pay a fee for early withdrawal. It’s also not uncommon for governments to increase the age to claim state pension. With that in mind, I think it’s a good idea to have a second income plan that ensures I can access my money if and when I need it.
I think the best way to do this is through a Stocks and Shares ISA.
Currently, I can invest £20,000 a year tax-free into a Stocks and Shares ISA, so if I stay below this amount I won’t pay any tax on interest, capital gains, or dividends. This enables me to harness my ISA as a means to cultivate income, such as through dividend payments, with the added advantage of tax-free withdrawals for the entirety of my 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.
The beauty of compounding interest
With some carefully selected shares, I’m aiming for 10% annual returns. This may seem unremarkable at first, with the initial £100 monthly investment yielding a modest £174 profit after the first year. However, after 10 years, this will have grown to around £20,000, and after 30 years compounding interest will have secured me approximately £200,000 in savings. (These are only projections and could change significantly based on inflation rates and market volatility.)
If I can maintain my goal of 10% returns, my £200,000 nest egg should now be accruing interest of £20,000 a year on average. Even if I stop making monthly contributions at this point, it should increase to around £30,000 a year after another five years. At this point, I could potentially live off the interest alone without even having to rely on my pension. However, on top of my pension, this interest would equate to a sizeable amount of disposable cash for a comfortable retirement.
In 2044, the UK retirement age for state pension is set to increase to 68, so I think there’s still lots of time to capitalise on this strategy — even for those in their mid-to-late 30s.
Admittedly, such a long time frame lacks the excitement of making quick money off growth stocks. But for only £100 a month, I can still afford to make short-term investments in the stock market with some additional cash, if I so wish.
I’m aware that while my 10% return target aligns closely with historical averages, inherent risks such as poor investing or economic stagnation could make this goal challenging. But with my pension as a backup, I see this as a low-risk strategy to potentially secure a very comfortable retirement.
The post I’m using this strategy to generate a second income stream for a comfortable retirement appeared first on The Motley Fool UK.
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