I’d use a Stocks and Shares ISA to invest in low-risk equities and let the passive income roll in

Stephen Wright thinks a Stocks and Shares ISA can be a valuable way of generating tax-efficient passive income even for more risk-averse investors.

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A Stocks and Shares ISA is a valuable vehicle for UK investors. It allows people like me to invest up to £20,000 per year in the stock market without having to worry about dividend tax.

This makes investing in an ISA a great way of buying shares to generate passive income. And I think there are some opportunities right now that even risk-averse investors should consider seriously.

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.

Preferred shares

Right now, Aviva (LSE:AV) shares come with a 7.42% dividend yield. That’s a good yield, but relying on this kind of investment is risky — the company has cut its dividend before and there’s no guarantee that it won’t happen again.

A less risky alternative is Aviva’s preferred stock, which trades under the ticker symbol ‘AV.B’. That comes with a fixed dividend, which offers a yield of 6.8% at today’s prices.

That’s lower than the yield on the common stocks, but the risk is also significantly lower. This makes preferred shares a much more stable source of passive income.

Aviva’s preferred shareholders are due a dividend of 8.375p per year. And this has to be paid in full before any remaining cash can be distributed to owners of common equity.

The significance of this came out in 2020. When the company had a bad year, preferred shareholders received their distributions in full, but the dividend paid to common shareholders went down.

In exchange for downside protection, preferred shares generally have limited upside. A fixed dividend can’t go down, but it also can’t go up, meaning owners of common stocks will do better if the business does well.

REITs

Real estate investment trusts (REITs) are another interesting asset class for passive income investors. These are companies that own properties and lease them to tenants, before distributing the income as dividends.

Dividends from REITs are not fixed, meaning they can go down. But it’s worth noting that they have a legal requirement to distribute their income, so any increases also get passed through to shareholders.

Primary Health Properties (LSE:PHP) is a REIT that I think is particularly interesting.The company has managed to grow its dividend each year for 27 consecutive years, making it a Dividend Aristocrat.

This means the company’s business model of focusing on primary care facilities has stood up well in various economic environments. Even during the pandemic, distributions to shareholders went up.

The company has a lot of debt on its balance sheet and this is a risk for shareholders to be aware of. Refinancing this at higher rates could cut into earnings and threaten the firm’s consistent growth. 

As a result, I’d say the 6.7% dividend yield comes with greater risk than Aviva’s preferred shares. But there’s also better scope for growth and the company’s record indicates that it’s much more resilient than most.

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.

Passive income

When investing in stocks and shares, some degree of risk is inevitable. But not all investments are alike when it comes to the possibility of things going wrong. 

Some, like Aviva’s preferred shares, have a status that insulates them from minor fluctuations in the business. Others, such as Primary Health Properties, have a business model that can hold up in difficult situations.

For investors looking for passive income, I think considering these types of investments could be a good idea. Over the long term, these could work out very nicely in a Stocks and Shares ISA.

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.

Stephen Wright has positions in Aviva (Preferred Shares) and Primary Health Properties Plc. The Motley Fool UK has recommended Primary Health Properties 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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