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Forget the Cash ISA! I’d pick up the FTSE 100’s 5% yield to make a passive income

The FTSE 100’s recent fall means it now has a dividend yield of around 5%. This is the highest it’s been for over a decade, and suggests income-seeking investors can secure a generous passive income from the index.

Of course, there are risks facing the FTSE 100’s prospects that may cause some individuals to prefer to hold their capital in a Cash ISA. But, with interest rates expected to remain low and the FTSE 100 having the potential to recover, buying a diverse range of large-cap shares may enhance your income prospects in the coming years.

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Dividend potential

Being able to obtain a 5% income return from the FTSE 100 isn’t a regular occurrence. In fact, it’s seldom offered such a high yield, the last time seen during a period of severe turmoil for the world economy and its banking system.

As such, now could be an attractive time to buy dividend shares to obtain a high yield and long-term growth potential. In many cases, FTSE 100 dividend shares have substantial headroom when making their shareholder payouts. Therefore, they may be able to withstand a period of slower economic growth without reducing, or even freezing, their dividend payments.

This could make income shares even more attractive compared to a Cash ISA. Not only do stocks offer an income return which is around four times higher than a Cash ISA, their dividend growth prospects over the long run may significantly widen the potential rewards between the two assets.

Cash ISA prospects

While the FTSE 100 has a strong track record of recovery, and looks set to bounce back from its recent downturn, interest rates on Cash ISAs could prove to be disappointing for many more years.

The Bank of England is currently displaying little appetite to raise interest rates. The UK’s economic future is uncertain due to Brexit, and now coronavirus, while low inflation means there’s little reason to raise interest rates. As such, Cash ISAs may offer negative real-terms returns over the medium term, which could lead to a loss of spending power.

Furthermore, with the first £1,000 of interest income from bog-standard savings accounts being tax free, there seems to be little, if any, tax benefit for most holders of Cash ISAs.

Starting today

Building a portfolio of FTSE 100 dividend shares may be an easier process than many people realise. A Stocks and Shares ISA is cheap and simple to open, while the low cost of sharedealing means that you can diversify across a number of holdings to reduce your overall risk.

While the FTSE 100 may fall further in the short run, its yield suggests that an appealing buying opportunity currently exists. As such, avoiding Cash ISAs and purchasing dividend shares could be a shrewd move.

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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.