Smart ISA Income Investments for 2026: Funds and Strategies for Tax-Free Returns
27 Feb, 2026
ISAs remain one of the most effective vehicles for building a tax-free income stream, but finding reliable returns in 2026 is harder than it was. FTSE 100 dividend yields have dropped below 3% for the first time in nearly 20 years, and corporate bond spreads are close to multi-decade lows, leaving income investors with less margin for error. That doesn't mean opportunities have disappeared — but it does mean they require more careful selection. This guide covers the most promising income-generating options for ISA investors right now, including value-focused global equity income funds, UK small and mid-cap opportunities, European funds with fixed income exposure, and lower-risk short-duration bond strategies.
ISAs remain one of the best ways to build a tax free income stream, but it’s up to you to pick the right underlying investments. A few years ago, income options were scarce, then as interest rates rose, investors could take their pick of stock market
and fixed income options. Today, generating a stable and growing income requires a little more discernment.There are two problems for income investors today. The first is that it’s been a great time in markets, valuations have gone up, so investors need to pay more for the same level of income. Previous income stalwarts such as the FTSE 100
have seen their yields drop. It now sits below 3% for the first time in almost two decades. The same is true for other high dividend markets such as Latin America and Europe.The other problem is that a similar phenomenon has been seen in bond
markets. Although government bond yields are relatively high compared to history, corporate bonds have become increasingly expensive. Corporate bond ‘spreads’ (i.e. the additional income investors receive for taking the risk on a corporate bond over a government bond) are near multi-decade lows and appear to offer little insulation against a tougher economic climate.This suggests an environment in which investors need to proceed with a bit more caution. With that in mind, one option for this year might be a value-focused global equity income fund. James Harries, co-fund manager of STS Global Income & Growth, has largely swerved the large, highly-valued technology names, preferring high-quality, predictable companies that provide downside protection.
We seek well-financed businesses that don’t need a lot of money to run the business. They typically have attractive margins, high returns on capital and sufficient funds to maintain operations, protect competitive advantages, support brand health and importantly, pay dividends. We favour sectors including branded consumer goods, healthcare and selective strong software businesses, despite current sector controversies. We also prefer high-quality industrials and non-bank financials, which are typically less leveraged and more predictable.
He says that investors don’t have to pay up for these qualities in today’s market:
The two-year bear market that followed the dotcom bubble is a reminder that when a market theme becomes overextended, recovery can take years. High-quality companies, such as consumer staples, that were overlooked, offered opportunities, while technology stocks declined and economies entered recession. Investors who overstayed their welcome in the most popular but overvalued companies suffered brutal losses. Fast forward to 2026, and reliable, high-quality companies now offer substantial value, just as they did in 2000.
Europe has been popular with investors this year. Recent data from research group EPFR, which tracks ETF and mutual fund flow, shows February as a record month for inflows. It has benefited from a desire among investors to diversify away from the US. The FTSE Europe ex UK index still yields a respectable 2.7%[1], and the markets have some good options for income seekers.
Lucie Meagher, private client investment director at Tyndall Investment Management, likes the Carmignac Portfolio Patrimoine Europe fund. This incorporates some fixed income holdings to boost the yield.
Within Europe, this fund offers an all-weather approach which it achieves by balancing a bottom-up stock and bond picking with macro-overlay and active risk management.
There are also opportunities closer to home. Research from Aberdeen shows that UK small caps
yielded more than large caps in January, for the first time in almost two decades. It showed that the bottom 10% of the UK Main Market by market cap yielded 3.4% on average, compared to around 3% for UK large caps.Valuations appear attractive, income is improving and the quality of businesses within the asset class is sometimes overlooked. UK smaller companies generate around half of their revenues overseas, spanning a wide range of geographies and business models, providing meaningful diversification beyond the domestic economy.
UK mid caps
also yield more than the FTSE 100 and also appear to offer a stronger pathway of growth. Diversified income funds such as the VT Tyndall Unconstrained UK Income fund or Jupiter UK Multi-Cap Income fund can roam up and down the market capitalisation depending on where the managers see value.One option for investors wanting a sustainability overlay would be the Jupiter Responsible Income fund.
This fund invests in UK dividend producing stocks aiming to generate an attractive income and capital growth. The managers employ strict ethical guidelines of areas they will not invest”. This means they naturally avoid many of the largest UK stocks.
This means they naturally avoid many of the largest UK stocks.
There are still opportunities within bond markets. Alex Farlow, associate director, multi-asset research at Titan Square Mile, says the AXA Sterling Credit Short Duration fund is a lower risk option.
It invests in short-dated corporate bonds which generate the fund’s income stream and which tend to be less volatile than the broader corporate bond market. About 20% of the portfolio matures each year meaning the manager can reinvest to secure higher yields, something which provides some protection against any future rises in interest rates. While the fund could be seen as a cash substitute for those comfortable with a higher level of volatility than cash, it should nonetheless generate a higher income over time.
Ian Rees, head of the multi-manager team at Premier Miton, also likes short-duration funds, particularly those that focus on higher quality bonds. He says that in the current environment, investors aren’t getting a lot of compensation for taking a risk on riskier investments. He likes the M&G range. This includes the M&G Corporate bond fund or the M&G Strategic Corporate Bond fund.
He says that asset backed bond funds may be another option for investors in the current environment. This acquired a difficult reputation during the financial crisis, but has cleaned up and now offers a good option for income investors. TwentyFour has a specialist Asset-Backed Income fund, which currently yields over 10%.
Income opportunities are not as abundant as they were. In particular, dividend yields have been dropping as share prices have been rising. There are still plenty of options for income investors, but they need to be approached with a little more caution.
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[1] Financial Times
