How much do you need in an ISA to aim for monthly passive income of over £1,000?

Thinking of stuffing an ISA with dividend shares as a way to earn passive income? That is exactly what lots of people do – and it can be a lucrative approach to generating some additional income without having to take an extra job.

Here’s how dividend shares work

To start, let me explain a bit about why dividend shares can potentially be lucrative. When a company generates spare cash, it typically has a choice of what to do with it. It might plough it back into marketing, for example, or invest in research and development.

Some firms decide to use a part or all of their spare money to pay dividends to shareholders. Simply by owning such a share could earn dividends.

But a couple of things are important to note. Dividends are never guaranteed, even when a company has paid them in the past. Also, share prices can move around, for better or worse – so the total financial return is not just driven by dividends, share price also matters.

Targeting a £1,000+ monthly second income

When assessing what might be earned from a dividend share, we look at its prospective dividend yield. That is the expected annual payout per share, expressed as a percentage of the purchase price.

The FTSE 100 yields 3.3% at the moment. In today’s market, I think it is possible to target a higher yield while sticking to proven blue-chip businesses. In this example, I will use 6%.

Earning £1,000 a month on average means an investor will need to generate over £12k annually in dividends, or more. At a 6% yield, that will require a £200k sum in the ISA.

That is more than the usual annual ISA contribution allowance. So that is where the idea of drip-feeding money in can be helpful. If someone puts £20k a year into their ISA and builds a portfolio of dividend shares that compounds in value at 6% annually, it ought to be worth over £200k after nine years. Invested at a 6% yield, that is enough to earn over £1k a month on average in passive income.

Choosing the right ISA helps

Clearly a key part of this approach is choosing the right shares. But total return can be eaten into by commissions, dealing fees and other charges. So choosing a suitable Stocks and Shares ISA is important too.

Finding shares to buy

One dividend share I think investors should consider is British American Tobacco (LSE: BATS). Its dividend yield of 6.1% is above the 6% target I mentioned above. The FTSE 100 cigarette maker also has a decades-long history of raising its dividend per share annually. It aims to keep doing so.

However, sales volumes are in long-term structural decline in many markets. Non-cigarette products have yet to prove anything like as profitable. That is a risk to British American’s cash flows.

But cigarette sales, while falling, remain substantial – and massively cash generative. British American owns a stable of premium brands that give it pricing power. It is also expanding more and more into non-cigarette products such as vapes.

The post How much do you need in an ISA to aim for monthly passive income of over £1,000? appeared first on The Motley Fool UK.

More reading

• How hard would it be to match the UK Pension by investing in dividend shares?
• With a share price up 33% this year and a 6%+ dividend yield, British American Tobacco’s on fire!
• How big should your Stocks and Shares ISA be to target a £500 weekly income for life?
• With no savings, here’s how a 50-year-old could still target a £43,000 annual retirement income
• 3 ‘no-brainer’ dividend growth stocks to buy with £3,000?

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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