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Why I’d generate a passive income with the FTSE 100 and a Stocks and Shares ISA

Generating a passive income may not be as challenging as it first appears. After all, there are a wide range of FTSE 100 shares that offer high dividend yields at the present time. In many cases, they also offer the prospect of significant dividend growth, which could produce a passive income that grows at a pace that is higher than inflation over the long run.

In addition, the availability of products such as a Stocks and Shares ISA makes tax-efficiency highly accessible for a wide range of investors. Over the long run, a Stocks and Shares ISA could provide a simple means of maximising your returns in order to generate a high passive income.

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FTSE 100 opportunities

As mentioned, the FTSE 100 offers a wide range of opportunities at the present time to generate a passive income. The index itself has a dividend yield of around 4.3%, although many of its members have yields that are much higher. In fact, around a quarter of the index’s constituents currently have dividend yields that are in excess of 5%. This suggests that it is possible to build a diversified portfolio of companies that together have a combined yield of around 6%.

Due to the international focus of the FTSE 100, a passive income generated from the index is likely to offer a significant amount of geographic diversity. Furthermore, the index’s range of sectors and businesses could provide reduced risk when an investor purchases a mix of stocks from different industries.

Looking ahead, the FTSE 100 could offer dividend growth opportunities. Many of its members currently offer improving financial outlooks in the current year and beyond, which could lead to rising dividends that increase at a faster pace than inflation. Since assets such as cash, bonds and property may offer lower yields and reduced income growth potential when compared to the FTSE 100, the index seems to have relative income investing potential.

Stocks and Shares ISA

Buying FTSE 100 stocks through a Stocks and Shares ISA is a logical means to maximise your passive income over the long run. It means you avoid paying capital gains tax and dividend tax. While they may not impact on your returns in the short run, over the long run they could have a growing negative effect on your returns – especially since there is the potential for tax changes during what is a fluid period for the UK political outlook.

Since up to £20,000 can be invested in a Stocks and Shares ISA each year, they are likely to be appealing to a wide range of investors. Likewise, their low charges and the simplicity of opening and managing them means that they are a highly appealing product through which to generate a passive income. As a result, now could be the right time to open a Stocks and Shares ISA and start investing in FTSE 100 stocks.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.