The threshold for dividend taxes is coming down to £500 this year. As such, a Stocks and Shares ISA has never been a more valuable resource for investors looking to earn passive income.
A new financial year brings a new opportunity to invest up to £20,000 in an ISA. And I think that kind of investment today could well grow into something paying £2,494 per year in dividends.
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.
Investment returns
What does it take to turn £20,000 into a portfolio returning £2,494 per year in passive income? The answer is 30 years and the ability to reinvest the dividends each year at 4%.
Right now, there are a number of stocks – both in the UK and the US – that have a 4% dividend yield. But investors should be cautious about withholding taxes on dividends from US companies.
UK investors pay a 30% withholding tax on dividends from US companies (reduced to 15% with a W-8BEN form). And a Stocks and Shares ISA doesn’t offer protection from this.
What looks like a 4.5% dividend might therefore amount to a 3.8% return for a UK investor. I wouldn’t rule out buying shares in US companies on this basis, but it’s worth keeping in mind.
Dividends vs. growth
There’s more than one way to aim for a 4% average return over 30 years. The first is by buying shares that are offering that kind of return right now and hoping they’ll maintain this.
The other is by investing in stocks that offer a lower dividend yield with the expectation they will distribute more in future. With my own portfolio, I try to stay open to either approach.
When I invest, I look to buy whatever I think the best opportunity is at the time. Sometimes that’s stocks with high dividend yields and other times it’s shares in companies with growth potential.
Right now, real estate and utilities look like promising sectors to me. They happen to be traditional areas for dividend investors, but I think there are unusually good opportunities at the moment.
Which stocks should I buy?
With their 6.6% dividend yield, I think shares in Primary Health Properties (LSE:PHP) look attractive at the moment. The company is a real estate investment trust (REIT) focused on GP surgeries.
Like a lot of REITs, the business has a lot of debt, which could be an issue over time. It’s possible the company might have to issue equity – diluting its shareholders – if it can’t refinance.
Even if this happens, though, I think the dividend yield should still be attractive. And with the firm’s portfolio largely occupied by government entities, the risk of rent defaults is low.
Furthermore, the company has managed to steadily increase its rents with inflation and the dividend has grown as a result. Below £1, it’s on the list of stocks I’d be happy to buy today.
Dividend income
Obviously, the best investments are the ones that offer high yields with future growth potential. I think Primary Health Properties falls into this category.
There’s more than one way to build a passive income portfolio. With £20,000 to invest today, I’d look to keep an open mind and identify opportunities wherever they present themselves.
