The Stocks and Shares ISA is essentially a wrapper that allows me to invest up to £20,000 each year, and shields me from capital gains or income tax. As such, it can be an excellent vehicle for our investments.
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.
To me, sometimes the Stocks and Shares ISA is under-appreciated by investors. In fact, when investing for passive income — in this case income derived from stock dividends — it makes perfect sense.
For example, if I were to earn £30,000 within the ISA and withdraw to fund my life, I’d pay no tax on this whatsoever. However, if this were outside the Stocks and Shares ISA wrapper, I’d be taxed at the basic dividend tax rate.
Achieving the passive income dream
One of the pre-conditions about earnings a passive income is that we need money to invest in the first place. And that’s obviously not easy for many of us.
As such, this means that many of us will need a growth phase. In other words, a period where we invest to grow our portfolio. This may involve further, ideally monthly contributions to our original pot, and definitely should involve reinvestment.
This allows us to benefit from something called compound returns. This is the process of earning interest on my interest.
The classic example of this is investing in a dividend-paying stock like Legal & General (LSE:LGEN). Every year, I’d reinvest the dividend — the yield currently sits at 8.2% — and the interest I earn would grow progressive larger.
Of course, it doesn’t need to be exactly like this. If I were to invest in growth-focused stocks, examples being Meta Platforms or Nvidia, I’d find these companies tend to the reinvesting for me. In other words, they’re ploughing back gains to deliver greater earnings in the future.
Lifelong passive income
Once my portfolio has reached a value I’m happy with, that’s when I should start to draw a passive income. I could obviously do this by investing in growth-oriented companies and selling my gains accrued from rising share prices. However, growth-focused firms can be more volatile.
Instead, I’d turn my attention to companies like Legal & General. Insurance stocks tends to offer strong dividends, and that reflects the mature nature of the business in the UK, but also strong cash flows.
Remember, cash flows are particularly important for dividends. If a company has a regular stream of cash — in the case of insurance companies this is the monthly or annual premiums we pay — they rarely face challenges paying the dividends on the stated date. Pharma firms that have to wait up to a decade for a product to reach the market are at the opposite end of the scale.
Moreover, Legal & General has benefitted from positive trends in Bulk Purchase Annuities. And this appears to be a tailwind that will endure this decade.
So while Legal & General might not be the most interesting company — it’s mature, slow growing, and does face some competition from fintechs — it’s also reliable and has a great track record of paying and increasing its dividend. That’s why it could be a great company to help me achieve a lifelong passive income.
