I love my stocks and shares ISA. It’s pliant, uncomplicated to exploit, and all returns are free of income tax, dividend tax and capital gains tax… for life. Many investors exploit them to generate tax-free passive income in retirement, and that’s my goal as well.

Please note that tax treatment depends on each client’s individual situation and may change in the future. The content of this article is for informational purposes only. It is not intended to be and does not constitute any form of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.

FTSE 100 dividends

How much investors need in their ISA to generate an income of £3,500 a month or £42,000 a year will depend on the profitability of the underlying investments.

Many people like to exploit the 4% rule when calculating payouts. If an investor takes this percentage as income every year, he or she should not be forced to deplete his or her capital. However, this requires a vast pool of money. To generate £42,000 a year, your ISA portfolio would need to be £1.05 million. It is possible to generate the same income from a smaller pot by using capital.

It is also possible to boost the profitability of the portfolio by investing in instruments with a higher rate of return FTSE100 dividend stocks. Let’s assume that the same investor increases his profitability to 5%. This would require a portfolio of £840,000. If they target a 6% profit, the required pot will drop to £700,000. These are still vast sums and will take years to achieve.

Someone who saves £575 a month and sees their investment grow by 7% a year would have almost £700,000 after 30 years. Compounding is our friend here. Dividend reinvestment means that the portfolio grows not only from novel contributions, but also from the dividends generated by the shares, which in turn generate more income.

BP – the company with the highest income?

On A motley foolwe prefer to buy individual stocks rather than tracker funds. One dividend stock that I personally own is an oil giant BP (LSE:BP). Currently, the final dividend yield is 5.7%, well above the FTSE 100 average of around 3.25%.

The share price is up just 2.5% in the last six months, but it’s up 90% in five years, which primarily includes dividends.

BP is a major energy player with significant global reach and recently made a major oil discovery near Brazil that could offset degenerating production in other countries.

In addition to a high dividend rate, BP also rewards investors with share buybacks. However, its stock has been volatile for years. Oil prices are notoriously cyclical, earnings can fluctuate wildly, and global events can quickly impact both earnings and share prices. The shift to renewable energy adds uncertainty as BP has chosen to remain primarily on fossil fuels.

Recently, there has also been talk of an excess supply of oil and a possible drop in its price next year, which will not have a major impact on the price of BP shares.

Regardless, I’m holding this stock and think it’s still worth considering in the long run. Investors need to look beyond the ups and downs of the energy price cycle.

Building a portfolio

The key to diversification. Owning a mix of high-yielding blue-chip dividend stocks in different sectors smooths out yields and reduces the risk of relying on a single payout. Building a balanced stocks and shares ISA takes years, but the benefits will definitely be worth the effort.

Start early. Stick to it. Spreading risk.