Here’s how I’d invest £20,000 in a Stocks and Shares ISA for dividend income in 2023

With a generous tax-free allowance on offer, here’s how our writer would use a Stocks and Shares ISA to build his passive income portfolio.

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I’m looking for new passive income ideas this year. With a £20,000 annual allowance to take advantage of, I think buying high-yielding dividend stocks within a Stocks and Shares ISA could be a great way to earn a second income.

Currently, the tax-free dividend allowance is £2,000. However, this will be halved to £1,000 for 2023/24 and reduced further to just £500 from 2024/25.

Optimising my portfolio to maximise my returns has never been more important in the context of UK tax changes. So, here’s how I’d use my £20k allowance.

My dividend income target

I like to be ambitious but realistic when setting investing targets.

The FTSE 100 index currently yields 3.55%. I reckon I can beat the index by carefully selecting high-yield UK dividend shares. With £20,000 to invest, I’d aim for £1,000 in annual passive income. That means I’d need a 5% yield from my portfolio.

I’d buy a range of dividend stocks in my ISA so my portfolio is diversified across different companies and sectors. If any single holding cut or suspended its dividends, I could hopefully rely on my other positions to continue providing regular passive income streams.

Here are a couple of examples I’m considering.

A FTSE 100 dividend stock

Among FTSE 100 stocks, National Grid (LSE:NG.) shares could be a good fit for my portfolio given its 5% dividend yield.

National Grid is a dividend aristocrat, boasting a 25-year history of dividend hikes. Utilities giants are traditionally some of the most reliable dividend stocks. I believe National Grid is no exception.

The latest financial results for half-year 2022 were promising. Underlying earnings per share increased 42% to 32.4p. In addition, the dividend grew by 3.7% to hit 17.84p.

Granted, the stock isn’t without risks. The company is undertaking an expensive capital investment programme to decarbonise the UK’s energy network. This could reduce the money available for dividends and possibly weigh on the National Grid share price.

Nonetheless, I like the solid dividend history and strong financials. If I had some spare cash, I’d invest today.

A FTSE 250 dividend stock

Turning to the FTSE 250, clay brick and construction materials manufacturer Ibstock (LSE:IBST) also offers a 5% yield.

The UK’s housing crisis is well-documented and much ink has been spilled on the need to build more homes. As the UK’s leading brickmaker, the company should benefit from this acute demand.

In a recent trading update the business confirmed it expects a 25% revenue increase to £510m for 2022, with adjusted EBITDA ahead of previous expectations.

Ibstock faces headwinds too from a cooling housing market as well as increased raw material and labour costs due to inflationary pressures.

However, despite the risks, I like the long-term outlook for the Ibstock share price. With some spare cash, I’d buy today.

Using a Stocks and Shares ISA

With future tax changes on my mind, I’m striving to use as much as I can of my £20k ISA allowance this year.

To maximise my passive income, I’d reinvest my dividends to benefit from a compounding effect over the long term. With a clear savings plan and disciplined investing strategy, I think I could hit my £1,000 annual dividend income target.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Charlie Carman has no position in any of the shares mentioned. The Motley Fool UK has recommended Ibstock Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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