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The average Briton saves a few hundred pounds every month, research shows. If put to work in the right way, that could create a healthy passive income for retirement. Here’s how.
Head for an ISA
According to insurance company Shepherds Friendly, the typical UK adult sets aside £330 monthly in a savings account. That’s not bad, I think. But this amount of money’s unlikely to generate life-changing wealth if not invested in the right way.
The first thing I’d do to maximise my returns is to deposit money in an Individual Savings Account (ISA). I won’t have to pay a single penny in capital gains tax or dividend tax, which can potentially save me thousands every year.
Plenty of choice
Investors have different ISAs to choose from too. A Cash ISA’s a standard cash savings account. Meanwhile, the Stocks and Shares ISA allows investment in a variety of different instruments like equities, bonds and funds.
Lifetime ISAs can be used to hold all of the above, with a 25% government top-up on deposits. However, they have an annual limit of £4,000 and certain restrictions.
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.
Making a plan
The amount of passive income I make will benefit from using a tax-efficient ISA. But the exact level of income I’d enjoy would depend on my investing goals and attitude to risk.
Putting cash in an ISA will give me peace of mind, but it will likely give me a much lower return than if I used my money to buy stocks or funds, for instance.
So what might be a good balance of the two? I think an 80-20 split between riskier assets (like shares) and holding cash on account could work nicely for me.
I could park 20% of my £330 monthly savings (£66) into a Cash ISA, and the remaining 80% (£264) into a Stocks and Shares ISA. This way I don’t need to worry about the early withdrawal penalties associated with the Lifetime ISA.
Based on a 4% savings rate, my Cash ISA would make me £45,807 over 30 years. And assuming I can enjoy a 9% annual average return with my Stocks and Shares ISA, I could generate £483,316 with dividends reinvested.
If I then combined both amounts and drew down 4% each year, I’d have a £21,165 passive income to supplement my State Pension.
A top fund
As I say, there are plenty of assets I can buy in a Stocks and Shares ISA. But a great way to try and achieve that 9% average yearly return could be to buy a FTSE 250 tracker fund.
More specifically, the Vanguard FTSE 250 UCITS ETF (LSE:VMID) might be the way to go. With an ultra-low management fee of 0.1%, it’s extremely cost-effective.
But why track the UK-focused FTSE 250, you ask? Well, since its inception in 1992, the index has delivered a mighty annual average return of around 11%. That’s not to be sniffed at and this ETF could be a great way to access such a return.
That said, while tracking the index might spread the risk, the ETF’s returns might disappoint if Britain’s economy fails to grow as strongly as in previous years. But on balance, I believe it could be a great way to build long-term wealth and is well worth considering.
