The tax benefits of a Stocks and Shares ISA are hard to overstate. Especially for investors looking to earn a second income from the stock market.
Being able to keep 100% of any dividends received can be huge. And that’s not the only benefit.
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.
UK income
According to the Office for National Statistics, the median UK salary is around £39,039 a year. After tax, that comes down to £31,628.
Assuming a 5% dividend yield (which I think is realistic) the amount needed to generate this return is £632,560. And the annual ISA contribution limit is £20,000.
I think someone who can invest that consistently each year has an excellent chance to reach £632,560. The biggest question is how long it takes.
To get there within 10 years, you’d need a 20.07% annual return. That would be extraordinary, but the equation gets much better with time. Getting there within 15 years requires a 9.89% return, which is high but not impossible. But at 20 years, the required return is just 4.95%.
That’s well below the long-term average from the FTSE 100. And it really highlights the power of investing regularly over time.
Where to invest?
I think there are plenty of stocks that could realistically offer 4.95% annual returns. But a few might even give investors a shot at 9.89%.
One that might manage this and could be worth a look is Games Workshop (LSE:GAW). The firm currently earns 625.9p per share and is priced at 19,304p.
A reverse discounted cash flow (DCF) calculation tells us the implied growth rate for a 9.89% return is around 10.5% a year. Is that realistic? It might be – over the last five years, the firm’s achieved 12.28% annual growth in earnings per share.
That’s no guarantee of future returns, but the company’s core strength is still intact. Its Warhammer franchise remains extremely popular. And while that remains the case, I think Games Workshop’s growth prospects are strong. And that’s not even the best bit for investors.
Dividends
In recent years, Games Workshop has returned almost all of its cash to shareholders. And I think there’s a good chance this can continue.
That means investors can generate some of the required 10.5% growth by reinvesting dividends. At 3% a year, that brings the target rate down to around 7.5%. I think there’s a very good chance the firm achieves this over the next 15 years.
But it’s important to pay attention to what could go wrong. Over 15 years, a lot could happen. Recessions could cut into consumer spending, preferences might shift, and inflation may push up manufacturing costs.
All of those are risks.But investing isn’t just about finding things that can go wrong, it’s also about identifying stocks that are likely to do well.
Games Workshop looks to me like a real candidate. I own it in my own Stocks and Shares ISA and I think it’s worth considering right now.
ISA investing
In a Stocks and Shares ISA, a portfolio with a 5% yield turns £635,560 into £31,628 a year. Outside an ISA, a basic rate taxpayer needs £693,400 to achieve this.
The extra £57,840 either takes more time, more cash, or a higher return. And that’s why investors shouldn’t underestimate the value of a Stocks and Shares ISA.
