A Stocks and Shares ISA is a popular way to earn passive income in the UK. By taking advantage of the dividends paid by many British companies, investors can aim to build a second income stream. Furthermore, no tax is levied on gains from the annual £20,000 investment limit.
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.
There’s a wealth of information online to help investors choose the ideal Stocks and Shares ISA for them. After all, there’s no point earning passive income from dividends only to lose a lot of it to account fees.
Defining goals
It’s important to set realistic targets about how much can be invested and the expected return. The return depends on the average yield the ISA can achieve from the cash invested in it.
For example, a 5% yield on £100 invested would return £5. Initially, the amount may be small but over time, the miracle of compounding returns could grow the investment exponentially. Eventually, even a small yield could return a decent amount of passive income.
Yields don’t remain fixed. They move inversely to the company share price and can change at any time. So it’s best to choose companies with a track record of reliable and stable dividend payments. This makes calculations more accurate. Still, any future projections are only rough estimates.
A share to consider
For example, British American Tobacco (LSE: BATS) currently has a 7.5% yield. It’s been paying an increasing dividend for 20 consecutive years, so its track record is good.
Tobacco stocks have lost popularity lately due to ethical concerns about smoking. Fortunately, the company aims to become predominantly smokeless within the next decade.
New legislation to limit smoking has also hurt the company’s profits and the transition to less harmful products is expensive. This is an ongoing risk the company must navigate if it hopes to remain profitable.
The share price is down 7.3% over five years but recovered 34% in the past year.
This is likely due to positive results in the first half of 2024, with revenue at £12.34bn and earnings of £4.47bn. Analysts expect earnings to grow a further 17% in the next H2 2024 results.
It’s just one of many high-yield dividend shares investors may consider on the UK stock market.
Building up an investment
A portfolio of 10 shares with stable yields between 5% and 9% could achieve an average yield of 7%. It’s also important to include the price growth as this will compound the investment further. The FTSE 100 average is around 5%.
To earn £11,880 a year in dividends (990 x 12) using the above averages, an investor would need around £738,270 invested. That’s way over the £20k annual ISA limit so it’ll need to be built up over a long period.
For example, by starting with a £20k lump sum and contributing £320 a month, the pot could grow to around £738,270 in 30 years (with dividends reinvested). Investors could also withdraw cash from the pot to increase their income. However, this would reduce the annual dividend over time.
