A Stocks and Shares ISA is a handy way to build a second income stream. AIl dividends and capital gains roll up free of income tax and CGT, while withdrawals are tax-free too. It means you can draw a regular passive income in retirement, without paying a penny of tax on it.

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Crunching the numbers

Let’s suppose an investor is targeting a second income of £1,750 a month. That works out at £21,000 a year.

Using the traditional 4% ‘safe withdrawal rule’, they’d need £525,000 to generate that level of income. That might sound like an enormous sum, but this is where the miracle of compound returns works its magic.

Let’s say an investor puts £350 a month into a diversified portfolio of FTSE 100 and FTSE 250 shares, returning an average 8% a year with dividends reinvested. Over 30 years, they could build a pot of roughly £513,850. There are no guarantees that investments will deliver 8% a year. Markets can be volatile in the short run. That’s why taking a long-term approach is so important.

A top FTSE 100 dividend stock

One FTSE 100 stock that might tempt income-focused investors is insurer Standard Life (LSE: SDLF), previously known as Phoenix Group. It currently yields 6.1%, one of the highest on the FTSE 100. Management has a strong track record of shareholder payouts, increasing them in each of the last 10 years.

Standard Life specialises in helping people save and invest for retirement, something that will be increasingly important as the population ages, and the State Pension comes under pressure.

First-half results (7 September) were solid. IFRS adjusted operating profit climbed 25% to £563m, while assets under administration increased 5% to £333bn.

The dividend looks solid too. Standard Life generated £900m of total cash. Its shareholder capital coverage ratio is 169%, in the upper half of its target range of 140% to 180%. The board hiked the interim dividend 2.6%.

There are risks. Insurance and retirement businesses are complicated, while a stock market crash would hit the value of the assets it holds to cover its liabilities. Standard Life is in the process of buying Aegon’s UK insurance and pensions operations. That would significantly increase its scale, but also brings integration risks.

Start small, think big

The Standard Life share price is up an impressive 45% in the last 12 months, but that’s unusual, and the pace of growth may slow. It looks a bit more expensive now, with a price-to-earnings ratio of 17. I still think it’s worth considering though. It would look even more tempting if we get a stock market dip in September. That could reduce the P/E, and allow investors to bag an even higher yield.

The important point is not to build the entire strategy around one share. Investors should aim to build portfolio of perhaps 15 to 20 companies spread across different sectors. Happily, I can see plenty more exciting second income stocks on the FTSE 100 right now.

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Harvey Jones owns shares in Standard Life.