A Stocks and Shares ISA allows people like me to invest in equities without having to worry about taxes on dividends or capital gains. That’s a big advantage for passive income investors.
Next year, the threshold for dividend tax is set to fall from £1,000 to £500. And I think this could have significant implications for investors over time.
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.
Dividend tax
UK investors can earn up to £1,000 a year in dividends without paying tax on them, but that’s coming down to £500 from April. Above that, the tax rate is 8.75% for basic rate taxpayers like me.
With investments held in a Stocks and Shares ISA, there’s no limit to the amount of dividend income someone can earn without paying tax. For long-term investors this could be important.
Right now, a number of stocks have eye-catching dividends. Suppose, then, that I invest £20,000 in shares with an average dividend yield of 5% and earn £1,000 a year as a result.
If I hold my investments in a Stocks and Shares ISA, I’d pay nothing in dividend tax. But from April if I held them outside that, I’d pay £43.75.
Compounding
That doesn’t sound like a lot, but it adds up over time. Over 25 years of investing, £43.75 a year adds up to £1,093.75 in missed income – but the situation is actually worse than this.
Not only would I miss out on the income I paid away as tax, I’d also miss out on the opportunity to invest it to compound my returns. And investing £43.75 a year for 25 years results in £2,274.
That’s £2,274 I could have had just by using a Stocks and Shares ISA. I wouldn’t have had to do anything else differently, just buy the same stocks and hold them in a tax-advantaged account.
To me, that makes the case for using a Stocks and Shares ISA to invest extremely strong. And a 5% dividend yield looks highly achievable to me with the state of the stock market at the moment.
A 5% dividend yield
One stock with a dividend yield over 5% that I like the look of is Forterra (LSE:FORT). The brick manufacturer isn’t big – it has a market-cap of £367m – but it is well-established.
Forterra’s products include the London Brick, which features in around 25% of the UK’s housing stock. And its operating margins (usually in the mid-teens) seem healthy.
Investors should be wary of taking the 7% dividend yield as a given with the UK’s low construction output. Since January however, there have been encouraging signs in the property market.
I think Forterra has the balance sheet and the operational discipline to weather a downturn and emerge on the other side. And when it does, I’m expecting it to be a strong source of passive income.
Long-term investing
The difference between investing in a Stocks and Shares ISA and not might seem minimal. But factoring in the opportunity cost of missed compounding means it can add up over time.
That’s why getting as close as I can to my £20,000 contribution limit is top of my list of ambitions every year. And it’ll be even more important when April comes around.
This post was originally published on Motley Fool
