By earning passive income in a stocks and shares ISA, investors can use the tax-free gains to fund a more luxurious lifestyle. Although it takes some time, investing a total of £20,000 in an ISA is more than enough to get going and earn a significant second stream of income, perhaps up to £18,000 a year. Here's how.

Determine portfolio goals

Historically, the stock market has offered a 4% annual return through dividends. But even as UK stocks reach record highs, there are still plenty of income stocks offering yields above 6%.

By focusing on these institutions, the portfolio can match this return. At 6%, the amount of capital needed to generate £18,000, or £1,500 a month, comes to £300,000.

Apparently this amount is just over £20,000. But thanks to compounding, investors can achieve this goal gradually over time. By reinvesting dividends paid over the short term and assuming the shares match an average annual market capital gain of 4%, an ISA portfolio worth £20,000 could grow to £300,000 in about 27 years.

Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content in this article is provided for information 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.

High yield opportunities

There are currently 46 stocks across FTSE 350 index Offering a dividend yield of 6% or more. This is a fairly diverse group of investment options, especially since these companies cover multiple industries and target markets.

However, as every experienced investor knows, having a high yield does not guarantee high investment returns. In fact, the higher the yield, the more likely a potential decline is on the horizon, as it is often an early warning signal of an increase in risks to come. As such, it is very important to examine each opportunity carefully.

For example, Ashmore Group (LSE:ASHM) currently offers an impressive dividend yield of 9.2%, yet the stock appears to be stuck on a downward trajectory since early 2021. At least, that was the case until April when its market value finally started to recover.

Hidden income opportunity?

The emerging market asset manager has had to endure a difficult couple of years, as international investment opportunities in developing markets dried up in the wake of the global economic slowdown.

Aside from falling asset prices, weak investor sentiment has exacerbated the difficulties, resulting in assets under management today being significantly lower than they were a few years ago. But despite these headwinds, profits continued to flow into shareholders' pockets.

The management seems confident of better times ahead. To be fair, the company has already begun to see net customer outflows moderate as emerging market stocks begin to rebound. In reality, MSCI Emerging Markets Index It has risen 37.8% since April – supporting Ashmore's recent recovery streak.

However, with a dividend paying out of £120m versus just £49m generated from operating cash flow, the group is using its financial resources to maintain shareholder bonuses. In the long term, this is not sustainable. If the suspected recovery in net customer flows, and hence management fees, fails as expected, a dividend cut may be inevitable.

This risk is the reason for the high return. This is something investors should consider carefully when creating a passive income portfolio. Personally, I am exploring other 6%+ return opportunities in the market today.