Image source: Getty Images
A popular way to use a Stocks and Shares ISA is a source of passive income streams.
Stuffing it full of dividend shares, the payouts can be used as passive income. But alternatively, they could be kept inside the tax-free wrapper the ISA offers, compounded to buy more shares.
How might such an approach look in practice?
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.
Choosing an ISA and an investment amount
The first practical step involves setting up the ISA.
There are lots of different potential providers and the cost structures can vary widely – over time that is something that can make a meaningful difference to financial returns. So it makes sense to do a proper comparison between them when choosing.
It is also important to decide how much to invest. Different people have their own individual financial circumstances and priorities, so will make their own choices.
In this example, though, I use £20k, the standard annual ISA contribution allowance.
Deciding a realistic passive income target
It can be helpful to set an annual target for how much passive income you would like to try and earn.
For example, the FTSE 100’s current yield of 3.1% would translate to £620 per year on a £20k ISA. At a 5% yield, the earning would move up to £1k per year, while some people may target a higher yield. In today’s market, I see a yield of 5% or slightly higher as realistic while sticking to quality blue-chips.
Whatever choice you make, it is important to understand that no dividend is ever guaranteed to last.
Even a big company like FTSE 100 distiller and brewer Diageo can slash its dividend. It did so this year. Until a couple of years back it had grown the payout per share annually for decades.
So it makes sense to diversify an ISA across multiple shares as a way to try and reduce the potential negative impact of any one share reducing or cancelling its payout. A £20k ISA is big enough for that.
It is also important to look beyond the current (or historic) yield offered by a share and focus on what you think it might produce in future. How solid are the business prospects? What about the free cash flows?
While no dividends are guaranteed to last, some feel inherently more stable than others. Taking time to dig into the details can help reduce the risk of future disappointment.
Is this a possible dividend-growing bargain?
Speaking of disappointment, one share that has been in the doldrums lately is specialist instrument maker Judges Scientific (LSE: JDG).
Down by two-fifths over the past year, the Judges Scientific share price recently hit a 12-month low.
However, that has pushed the dividend yield up to 3.5%. Not only that, but Judges’ focus on instruments where precision matters means it has pricing power.
It has been able to translate that into profitability and annual double digit percentage growth in its dividend per share.
As the share price crash suggests, all is not well. The first half of the year saw it fall to a pre-tax loss. Weakened demand in China and spending constraints hurting US clients’ procurement both remain risks.
Still, while I recognise the risks, I think the share’s long-term dividend growth potential makes it worth considering.
What income stock do we like better than Diageo Plc right now?
One of our Share Advisor analysts has just released a brand new stock report that we think is a must-read for any investor looking to try and generate potential income.
And the best bit is that you can see if for yourself, right now, absolutely free of charge!
No jargon. No hard sell. Just a clear look at an income share we think is worth your time.
Christopher Ruane owns shares in Diageo.
This story originally appeared on Motley Fool
