The Stocks and Shares ISA allowance is a brilliant way to generate passive income because it’s 100% tax-free. Investors get to keep every penny of the dividends they earn, and there’s no need to include ISAs on tax returns.
Many people play safe by generating income from a Cash ISA, which is essentially a tax-free savings account. With interest rates relatively high, they can currently get up to 4.5% a year on a one-year fixed-rate Cash ISA or 4.2% fixed for five years. And their capital’s secure.
I’m using my Stocks and Shares ISA for tax-free wealth
Personally, I don’t take that route. While I keep some cash on easy access for emergencies, my long-term savings are all invested in the stock market. For me, it’s a no-brainer.
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.
Moneyfacts figures show the average annual total return from a Stocks and Shares ISA over the past decade is 9.6% a year. This includes both share price growth and dividend income. By comparison, the average Cash ISA returned just 1.2% annually.
While today’s higher interest rates may narrow the gap, savings accounts are unlikely to match the long-term total return of shares.
Of course, stock markets can be volatile in the short term, which is why I never invest with less than a five-year time horizon. The real rewards come over decades. That’s how I’m building wealth for retirement.
The blue-chip FTSE 100 index is filled with fantastic high-yielding shares like insurer Aviva (LSE: AV), which currently offers a trailing dividend yield of 6.77%. Over the past year, its shares have climbed more than 14%. Combined, that would have delivered a total return of over 21%.
Neither the share price nor dividend is guaranteed. Aviva’s share price could fall in the next 12 months for all anyone knows. However, the company seems well-positioned. Its board has been streamlining operations and focusing on core markets in the UK, Ireland, and Canada. This should boost efficiency.
The shares come with a dazzling yield
Additionally, demand for retirement and investment products is growing as the population ages. Aviva operates in the competitive financial services sector, and factors like economic downturns or market instability could hit profitability. Yet over the long run, I expect its dividend and share price to rise steadily.
It’s wise to spread risk across 10-15 dividend-paying stocks, in the hope that if one or two underperform, others will more than compensate.
Let’s say an investor puts their £20,000 ISA allowance into shares growing by 9.6% annually. After 20 years, they’d have £125,000. Staying invested for 30 years would increase this to an impressive £312,857.
If those shares yielded an average second income of 6%, they’d generate £18,771 a year. And that’s without touching the capital. It works out as £1,564 a month. Not bad from an initial £20k. And with luck, the income would grow over time. I do think it’s worth further research.
To me, that makes a compelling case for investing in a Stocks and Shares ISA over cash.
This post was originally published on Motley Fool
