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Forget the top Cash ISA rate. I’d pocket 5%+ from income stocks

It’s fair to say that it’s a miserable time for UK savers at the moment. Savings account interest rates are dreadful. Cash ISA interest rates are just as bad. And to top it all off, earlier this week, the interest rate on Premium Bonds was slashed.

Of course, if you’re willing to accept a little risk, there are plenty of ways to earn a higher return on your money at the moment. Here, I’ll explain how ‘income stocks’ could help you generate a yield of 5% or higher on your money, tax-free.

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Income stocks explained 

Income stocks are those that pay their investors regular cash payments out of the underlying company’s profits. The payments are called dividends. When you own an income stock, you get paid a share of the profits on a regular basis for being a part-owner of the business.

In the UK, there are plenty of well-known income stocks and many pay their shareholders very generous income streams. Compared to the interest rates on offer from Cash ISAs and savings accounts, the yields on some income stocks are incredible.

Income stock examples 

Take FTSE 100 oil giant Royal Dutch Shell, for example. Last year, it paid its investors $1.88 per share (about £1.46 per share at current exchange rates) in dividends. Now, Shell’s share price is currently about £19. So that means that the yield on the current share price is roughly 7.7% (£1.46/£19 = 0.077). Buy the shares today at £19, and you could potentially earn an income return of 7.7% for the year (assuming Shell pays the same amount of dividends this year and the exchange rate remains constant).

Legal & General Group is another good example of an income stock that offers a stunning yield at the moment. It’s expected to pay out dividends of 17.5p per share to its investors for the 2019 financial year. At its current share price of 314p, that equates to a yield of 5.6%.

There are many more companies in the FTSE 100 that currently offer yields in excess of 5% including the likes of insurance firm Aviva, broadcaster ITV, advertising specialist WPP, and tobacco giant British American Tobacco.

Put together a portfolio of FTSE 100 income stocks within a Stocks and Shares ISA, and you could be looking at a yield of 5% to 6%, or even higher, completely tax-free. That certainly beats the abysmal returns on offer from Cash ISAs right now.

Risks to consider

Of course, it’s important to understand the risks of investing in income stocks. When you invest in the stock market, the value of your portfolio will fluctuate every day. Given the volatility of stocks, it’s generally recommended that you invest for at least five years. This kind of investment horizon will give you time to ride out the volatility.

Each company also has its own unique risks to consider. And if a company’s profits fall, the dividend payout can be reduced, or even cut completely.

Overall, however, I believe income stocks offer a lot of appeal in the current low-interest-rate environment. With yields of 5%+ on offer, they can help you earn a higher return on your money.

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Edward Sheldon owns shares in Royal Dutch Shell, Legal & General Group, Aviva, WPP and ITV. The Motley Fool UK has recommended ITV. 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.