Earning a tax-free passive income has never been easier for UK investors. By harnessing the power of a Stocks and Shares ISA, individuals can gradually and sometimes rapidly build wealth without HMRC knocking at the door. And if that wealth is then allocated towards dividend stocks, all investors have to do is sit back, relax, and watch the money roll in.
Even an extra £100 a week can be unlocked in a relatively short space of time by individuals with a modest income. So how long will earning the equivalent of £5,200 a year take? And how much money needs to be put into an ISA to achieve it?
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.
Running the numbers
Dividend stocks can come in all sorts of shapes and sizes, each offering different yields. On average, companies typically pay close to 4% a year. But by being selective and taking on a bit more risk, it’s possible to earn more, with some income stocks maintaining payouts close to a 7% yield today.
At this level of yield, to generate £5,200 a year, an ISA would need to be worth £74,285. Obviously, that’s a pretty hefty chunk of change. But the good news is that investors don’t need to have this cash ready overnight. Instead, it’s much easier (and often cheaper) to use the stock market to build to this threshold over time.
Let’s say the high-yield portfolio is able to generate a total return of 9% a year, thanks to a little extra growth from capital gains. In this scenario, drip feeding £500 a month will gradually build a near-£75k tax-free nest egg in around eight and a half years.
Getting started
Looking across the London Stock Exchange, there are currently 74 companies offering a yield of 7% or more. But in many cases, these ‘generous’ payouts are actually a warning sign of risks lying ahead. Don’t forget, if shareholders flee, the stock price falls, and the yield goes up.
The mission for high-yield investors is to spot the instances where investors have overreacted and accidentally created a lucrative buying opportunity.
With that in mind, let’s look at an area of the stock market that’s particularly unpopular right now – real estate. And specifically zoom in on the 7.2% yield offered by Supermarket Income REIT (LSE:SUPR).
Earning real estate income
The business manages a portfolio of 82 retail properties, occupied by UK supermarket giants such as Tesco and Sainsbury’s.
These retailers pay rent to this commercial landlord, which then uses the money to service its debts and reward shareholders with a chunky dividend. And with most tenant leases typically spanning over a decade, management has enjoyed superb revenue visibility that’s paved the way for seven years of back-to-back dividend hikes.
So what’s the catch? While rent collection and occupancy both stand at a perfect 100%, the balance sheet is nonetheless stretched with debt. And following aggressive interest rate hikes over the last few years, the company’s now paying out more to shareholders than it’s bringing in, albeit by a small margin.
But this may be a risk worth considering. As interest rates gradually continue to fall, the pressure of debt is steadily being alleviated. Assuming this trend carries on and tenants continue to pay rent on time, Supermarket Income REIT could continue being a lucrative source of passive income.
