By developing the passive income potential of a stocks and shares ISA, it helps to understand the difference between the ‘accumulation phase’ and the ‘withdrawal phase’.

The biggest difference, in my opinion, is the huge gap in target returns. This is because investors who are still building their ISAs in the ‘accumulation phase’ may be aiming for a higher rate of return. Many investors generally aim for the 10% level. This is quite a realistic goal because it roughly matches historical rates of return – but there is a catch!

The ups and downs of the market make trying to do this every year a recipe for disaster. The FTSE100 for example, over the last five years the return was 14.9%, 10.9%, -0.8%, 26.7% and -15.3%. Therefore, if you are using an ISA to earn passive income during the withdrawal phase, a lower return is recommended to better protect your hard-earned money.

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.

Snowball

Let’s take the example of a passive income of £1,847 per month. That’s roughly the minimum wage today after taxes. This income would be quite handsome when combined with a state pension or mortgage repayments.

When we reach the withdrawal phase, our goal is to withdraw a diminutive amount from our nest. Some people call 4% each year the “safe withdrawal rate.” This means we can withdraw 4% annually for decades with low risk of erosion of initial capital. With this number, a passive income of £1,847 requires £554,000. pounds in a Stocks and Shares ISA – not exactly pocket money!

However, the difference between our total return and the amount we withdraw is a key concept to understand. First of all, this is the reason why we don’t have to accumulate the entire half a million at once, but we can work towards it. Even a few hundred pounds a month can operate the snowball effect of compound interest to achieve savings of many hundreds of thousands.

Wallets

It’s no secret that there are a lot of stocks on the market London Stock Exchange pay much more than 4%. For example, Phoenix (LSE: PHNX) currently offers a dividend yield of 7.86%. This doesn’t seem like a flash in the pan either. Forecasts for the next two years are 8.01% and 8.24%. Does this mean we can withdraw these higher amounts? Well, yes and no.

Yes, because building what some call a “high-yield portfolio” around huge dividends is a sound strategy. While double-digit returns are almost always unsustainable, higher single-digit returns outperform. For example, Phoenix has offered over 6% for the last 10 years.

On the other hand, this strategy carries risks. One of them is lower share price appreciation. Phoenix’s share price has only increased slightly, even if it went back a decade or more. Share prices may also fall, leading to a smaller pile of cash in my ISA.

Another risk is simply that dividends are never guaranteed. The 2008 crisis triggered a series of dividend cuts and cancellations. Similarly, the 2020 pandemic. One of the historical great dividends Shellincreased every year since 1945, was canceled after a diner in China made the somewhat unwise decision to eat a bat for dinner.

Personally, I think Phoenix is ​​one of the better performing stocks on the FTSE 100. I’d say it’s worth considering.