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A Stocks and Shares ISA can be used to build wealth in a tax-efficient wrapper. But different investors have their own goals and needs. Some may be happy for capital gains to stay inside the ISA, while wanting to withdraw dividends as passive income.
When doing that, here are some points they may want to consider.
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.
Money taken out of an ISA is out for good
To start with, there is the basic principle of the annual ISA contribution allowance.
Once money is taken out, it cannot be put back in unless there is some unused allowance left.
So, if an investor has put £20,000 into a Stocks and Shares ISA then takes out dividends from it, they will not be able to put them back in using that year’s ISA allowance.
Balancing risk and reward
What is a realistic dividend yield for an ISA?
One approach might be to focus on the average yield of the FTSE 100, currently 3.6%.
Another could be to aim for a higher yield, as the FTSE 100 contains a mixture of growth and income shares. Sticking to income shares could allow for a higher yield than the average.
But it is important to stay diversified, not just among shares but also business sectors. Many of the FTSE 100’s current high-yield shares are in the financial service sector, for example. A £20,000 pot is ample to diversify across different shares in a variety of sectors.
Some high-yield shares have big yields for good reason. For example, an anticipated profit decline may see the dividend cut. That can be painful enough, but often a dividend cut can also precipitate a share price fall too.
So, when investing, an investor ought not to focus only on yield, but also to consider how sustainable a company’s dividend seems to be.
Still, in today’s market, I do think a 5%+ yield while sticking to high-quality FTSE 100 shares is achievable. That would equate to an annual passive income of £1,000.
Finding shares to buy
As an example, one share I think investors should consider is British American Tobacco (LSE: BATS).
At 6.3%, it certainly has a juicy yield. As I discussed above, that points to some of the risks, such as a high net debt combined with declining numbers of cigarette smokers in many markets.
But the company has long faced such challenges, yet has still grown its dividend per share annually for decades. It aims to keep doing so.
The risks are notable, but British American has a simple, proven business model that combines global reach and economies of scale with premium brands that give it pricing power.
British American has challenges ahead, undoubtedly. But it also has significant strengths and continues to generate billions of pounds in annual free cash flows.
Keep a lid on costs
Is a 5% yield on a £20,000 enough to earn £1,000 a year of passive income from dividends alone?
The answer may not be as obvious as it seems. That is because an ISA provider will often impose charges that can eat into the amount earned.
So, the savvy investor will carefully compare different Stocks and Shares ISAs when seeking to find the one that best suits their own needs in a cost-effective manner.
