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Forget the Cash ISA! I’d buy FTSE 100 dividend stocks for a passive income

At the time of writing, the best Cash ISA on the market offers an interest rate of just 1.31%. This is for an easy access product.

You can get a little bit more for your money if you are willing to lock it up for longer. For example, rates of up to 1.7% are on offer for one, three and five-year fixed deals.

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Cash ISAs can be a useful tool to save for the future, as you’ll never need to pay tax on cash balances. However, with interest rates where they are today, it does not make much sense to open one of these products right now.

Instead, FTSE 100 dividend stocks might be a better alternative.

Cash ISA alternative

Owning stocks might seem like a riskier proposition compared to owning cash, especially at the moment. But today’s Cash ISA interest rates do not even match inflation, which means your money will lose purchasing power over the long run.

This lack of inflation protection could be even more damaging to your wealth over the long term than stock market volatility.

On the other hand, some of the market’s best income stocks support much more attractive dividend yields than the best Cash ISAs on the market today.

The trick to finding good dividend stocks is to look at dividend cover, rather than concentrating on yield alone.

High yielding dividend stocks might look attractive at first glance, but a high-yield often signifies a lack of confidence in the payout. A sudden dividend cut can cause a share price to plummet, eliminating years of income in a single trading session.

Therefore, stocks with lower yields and higher payout cover ratios tend to be the better income investments over the long run.

Dividend champions

Following recent market declines, some of the FTSE 100’s best income stocks are now on offer.

For example, real estate investment trust (REIT) Segro currently offers a dividend yield of 2.1%. This is 0.4% higher than even the best fixed rate Cash ISA on the market at the moment.

The dividend yield is covered 4.4 times by earnings per share, so it looks exceptionally safe for the time being. The payout has been increased for seven consecutive years. It has grown at a compound annual rate of 7% since 2014.

Global engineering giant Smith & Nephew also offers more in the way of income than the best Cash ISA on the market right now.

The stock supports a dividend yield of 1.8% at the time of writing. The payout has also been increased for seven consecutive years. It is currently covered three times by earnings per share, implying there’s plenty of room for further dividend growth. 

And finally, homebuilder Taylor Wimpey offers its investors a dividend yield of 9.3%. The distribution is covered 2.7 times by earnings per share.

Moreover, at the end of its last financial period, the company’s cash balance was equal to management’s planned distribution for 2020. That suggests that even if the company stopped operations tomorrow, it would still be able to return cash to investors.

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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.