The new tax year is coming up shortly, which means it’s time for me to add fresh cash to my Stocks and Shares ISA. As it offers tax-free dividends and no capital gains taxes, I try to maximise my allowance.
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.
This year I’ll focus on UK shares that could one day provide a juicy passive income. Unlike many US growth shares that are experiencing a shaky start to the year, several UK dividend shares are in demand.
As an example, shares in UK banking giant Lloyds Group are up by 45% over the past year and 25% year to date.
Despite recent strength in many FTSE 100 shares, I think there’s more to come.
Crunching the numbers
Before I discuss which shares I’m focusing on, let’s crunch some numbers. I certainly wouldn’t be able to earn more than £7k in passive income from one £20k investment as that would be a 40% return. Not without far greater risks anyway.
But by consistently filling my annual Stocks and Shares ISA, and investing over five years, I expect to build a much larger pot. Given a 10% annual growth rate, I calculate I can reach an ISA worth £122,102.
Then, to achieve £7,326 of annual passive income, I’ll need to earn a 6% dividend yield. I think this sounds achievable, given so many FTSE shares offer such a yield.
I have to bear in mind that neither the 10% annual growth rate nor the 6% dividend yield are guaranteed. However, I do think they are reasonable assumptions. In fact, many of the FTSE dividend shares that I’m thinking of have decades of consistent dividend history.
Dividend shares for my ISA
For my new ISA, I’m consider a selection of these quality dividend shares. That way, I won’t be putting all my eggs in one basket.
My top dividend pick right now is Aviva (LSE:AV.). This insurer is focusing on capital-light growth and it seems to be working. It recently expressed how it has clear trading momentum that’s generating strong and reliable growth.
Operating profit climbed 20% to £1.8bn, ahead of market expectations.
The proposed purchase of Direct Line should add further capital-light profits. This acquisition is expected to complete by the middle of this year.
This all bodes well for Aviva’s dividends. It has a multi-decade history of distributing cash to shareholders in the form of dividends. It currently offers a 7% dividend yield, and it has typically averaged around this level over the past five years.
Something to bear in mind
Note that dividends aren’t guaranteed and payments can be cut or suspended, as we saw in 2020. Also, bear in mind that Aviva’s investment returns could be affected by economic downturns.
That said, insurance premiums provide resilience, and these cash flows underpin sustained dividends. So, it’s encouraging that premiums gained 14% year-on-year to £12bn.
In addition to Aviva, I also like HSBC, BP, and Schroders. All three of offer a 6% yield and long dividend histories, and are all established businesses.
If I’m able to add a fresh £20k to my new ISA this year, I’ll split my pot equally between these four dividend shares. But note that they will form part of a more diversified portfolio.
