With the annual contribution deadline for a Stocks and Shares ISA just weeks away, now is as good a time as any to think about the different possible ways to use an ISA.
One choice can be to try and generate passive income. With the tax-free benefits of an ISA, money put into it now could potentially be generating passive income streams, free of tax, for decades to come.
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.
Choose your number!
In this example, I will presume someone wants to invest the standard annual contribution allowance of £20k and target an annual passive income of £1,900.
In fact, the same approach could work with less money in the Stocks and Shares ISA – or an even bigger income goal. But it would take correspondingly longer.
Getting the right ISA
One thing that can eat into those passive income streams is fees, commissions, and other charges levied by the investing platform provider.
So, it makes sense to shop around and choose the right Stocks and Shares ISA.
Using £20,000 to target £1,900 per year
£1,900 is 9.5% of £20k. No FTSE 100 share yields 9.5%.
So, is it a realistic target?
I think so, for someone willing to take a long-term approach to investing.
Imagine someone invests the £20k in a diversified portfolio, yielding an average 6.5%, then initially compounds (reinvests) those dividends. (Doing this in the Stocks and Shares ISA should mean capital gains, as well as dividends, are tax free).
After seven years, the ISA ought to be big enough that a 6.5% dividend yield would produce over £1,900 per year of passive income in the form of dividends.
Turning on the income taps
One share I think investors should consider for its income potential is FTSE 100 financial services provider Legal & General (LSE: LGEN).
The company aims to grow its dividend steadily by 2% per year.
That might not sound like much and is less than the 5% a year the firm managed a few years back.
But it is already the highest-yielding share in the blue-chip index of leading shares, offering 8.8%. At a time when the FTSE 100 yield is barely a third of that, at 3%, Legal & General’s juicy payout grabs attention.
Can it last?
Last week saw the company grow its annual dividend again. In the short term that is good news. Longer term, though, earnings have not recovered to their level of a few years back and the sale of a large US business will eat into revenues.
Another risk is volatile financial markets leading to policyholders withdrawing cash. That could hurt cash flows. It is no coincidence that Legal & General last cut its dividend during the 2008 market upheaval.
Still, the company is profitable and remains firmly cash generative. The US sale has brought with it a large cash sum. The underlying business continues to benefit from ongoing demand, a large base of customers, and a proven business model.
No dividend is ever guaranteed, but I do see Legal & General as a share for investors to consider.
