An income you don’t have to work for is often seen as the preserve of fortunate ‘trustafarians’, whose families use trusts to pass wealth down through the generations.
But you can use your Isa to provide your family with a source of tax-free money, too.
The trick is to choose investments that pay out a regular income. As long as they are sheltered in your Isa, the income paid out is completely free from tax – a welcome top-up for your salary or pension that you don’t have to declare to HM Revenue & Customs.
Pick wisely and you could achieve a steady, sustainable income. However, it is not simply a matter of selecting investments that pay out the most, as our experts reveal.
How do you make the right choice?
Some investment trusts, funds and companies pay out income in the form of dividends. These are payments made to shareholders as reward for investing.
Bonds pay out coupon payments, which are a form of interest paid by companies and governments to holders of their debt. And, of course, savings typically pay out an income in the form of interest.
To discover whether an investment will provide you with an income you need to look at the ‘yield’. This is the amount of money the investment will pay you regularly compared with the price of the investment itself.
Savvy: Provide your family with a tax-free income source
For example, if a company’s shares cost £100 each and it pays out a dividend of £5, the yield is 5 per cent.
However, the yield on an investment rarely comes with a guarantee. Payments can be cut at any time – and the value of it can move down as well as up.
Experts suggest that investors looking to produce a regular income should put their money into a range of different assets, so they are not overly exposed if one type proves disappointing.
This could include funds that hold shares, bond funds as well as some cash.
Dan Coatsworth, analyst at investment platform AJ Bell, says: ‘Investors reliant on their portfolios to generate an income to help pay the bills are naturally drawn to high yield investments.’
However, he adds that in some cases these yields are high because companies are out of favour with the stock market and it isn’t always clear when their share price will rise again.
They need to offer a high yield to convince people to buy their investments.
In some cases, too, high dividend yields may be unsustainable if a company is struggling to make a profit.
With the right investments, you may be able to produce an income of 5 per cent every year. If you had a £20,000 Isa pot, a 5 per cent income would be significant.
You’d have an extra £1,000 a year to help cover the bills, and no need to pay any tax on it.
If you saved your full Isa allowance every year for five years, you’d have an Isa pot of £100,000, generating an extra £5,000 a year, tax-free.
Darius McDermott, of fund and trust expert FundCalibre, says a 5 per cent yield is ‘ambitious but achievable’, provided that you pick the right funds.
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