£20k in savings? Here’s how much passive income I’d earn from these 7 dividend shares

Investing in dividend stocks is my favourite way to generate passive income. If I had £20k in savings, I’d maximise my Stocks and Shares ISA allowance this year by investing in a hand-picked dividend portfolio.

That’s because the tax benefits of ISAs can be considerable. Since the tax-free dividend allowance has been cut to just £500, it’s never been more important for investors to find ways to keep the taxman at bay.

For those fortunate enough to be able to fill their ISA this year, here are seven dividend stocks worth considering.

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.

Dividend investing

Although the potential rewards are significant, passive income investing involves risks. Indeed, all stock market investments are subject to volatility and share price fluctuations.

Furthermore, companies can cut or scrap dividend payouts due to financial challenges or strategic shifts. This risk’s particularly acute with so-called ‘yield traps’ where a firm’s superficially attractive dividend yield is higher than it is able to sustain over the long term.

That said, I’m hopeful the stocks mentioned in this article will prove to be healthy passive income providers over the coming years, even if there are no solid guarantees.

A FTSE 100 heavyweight

To kick off, let’s take a closer look at a FTSE 100 dividend stock I own with a long track record of delivering big payouts — British American Tobacco (LSE:BATS).

The cigarette colossus behind Lucky Strike and Pall Mall is one of the index’s top dividend shares, offering a massive 9.4% yield.

Currently, I think the stock offers excellent value with a price-to-earnings (P/E) ratio of just 6.7. Not only that, but it also boasts a robust history of dividend growth stretching back more than 20 years.

British American Tobacco benefits from predictable cash flows, high profit margins, and strong brand loyalty. These qualities all underpin the generous dividend policy.

Nonetheless, the business isn’t immune to challenges. A shrinking consumer base for tobacco products and an increasingly stringent regulatory environment are common difficulties for all firms in the industry.

Furthermore, the £34.6bn net debt pile on British American Tobacco’s balance sheet seems high measured against a £55.5bn market cap. Encouragingly, the group’s taking steps to tackle this, evidenced by last year’s 12% net debt reduction.

Diversification

Looking beyond British American Tobacco, a good way to mitigate the risks of dividend investing is diversifying a portfolio across different companies and sectors.

Other FTSE 100 stocks worth considering include asset manager Legal & General, banking giant Lloyds, and pharma stock GSK. They offer dividend yields of 8.7%, 4.6%, and 3.8%, respectively.

I’d also expand my search to the mid-cap FTSE 250 index, which contains plenty of dividend stalwarts.

For instance, Egypt-focussed gold miner Centamin might add some handy counter-cyclical diversification. As could Ashmore Group, an investment manager dedicated to emerging markets.

Finally, I’d also consider adding a real estate investment trust to the mix for further variety. Supermarket Income REIT offers exposure to retail property and packs a tasty 8.2% yield.

Collectively, these dividend stocks would provide an average yield of 6.6%. If I split my £20k pot evenly between all seven, I could expect to earn around £1,320 in passive income every year.

Now that’s what I call an incentive to fill up my ISA!