Tax optimisation is an important consideration when it comes to maximising my returns from stock market investing. This is why I’m striving to make full use of the £20,000 annual allowance that I can contribute in a Stocks and Shares ISA before the deadline on 5 April.
So, here’s how I’d target a lifelong passive income stream by investing in an ISA this tax year.
Using a Stocks and Shares ISA
Reductions in the UK’s capital gains tax and dividend allowances are coming. With that in mind, it’s arguably more important than ever to think about how my stock positions will be taxed and how this can affect my returns.
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I’m a long-term investor. I buy and hold stocks with a long time horizon in mind. This can allow me to ride out stock market volatility and hopefully secure good returns over the coming years. However, big returns can mean significant tax liabilities when the time comes to crystalise my investments or even on my regular dividends.
That’s where using a Stocks and Shares ISA comes into play. Due to the tax-free treatment of capital gains and dividends under the current rules, I can keep my investments sheltered within the ISA wrapper to make sure I avoid some tax liabilities.
A recent proposal from the Resolution Foundation recommended a £100,000 limit on ISA savings. However, as things stand, that’s just a suggested policy from a think tank. Nonetheless, in this context, I think it’s crucial to make full use of my annual allowance while I can, as there’s a risk ISA rules could become less generous in the future.
Investing in dividend stocks
Selecting high-yielding dividend shares is my preferred strategy for building passive income streams. In particular, I like to concentrate my investments in Dividend Aristocrats. These are companies that have maintained or increased their shareholder payouts over long time periods.
One example of a Dividend Aristocrat I invest in is British American Tobacco. The stock currently yields 6.97%. This is considerably above the FTSE 100 average. However, it’s important to bear in mind dividends aren’t guaranteed. After all, this company faces long-term headwinds as the number of tobacco consumers continues to dwindle.
Accordingly, I make sure my stock market positions are diversified across multiple companies. That way, if any one passive income stream dried up due to profitability concerns affecting an individual company, I could hopefully continue to rely on dividends from my other holdings.
Other dividend stocks I own include pharmaceutical giant GSK, which yields 6.06%, and supermarket Tesco, which yields 4.63%. Their dividends aren’t guaranteed either, but I’m spreading my risk across companies and sectors.
Passive income for life
Let’s say I managed to secure a 5% dividend yield across my portfolio. By using my full £20,000 ISA allowance, I could secure £1,000 in passive income every year.
If I continued to deploy as much cash as I’m able to in my ISA every year and reinvested the dividends, I could begin to benefit from a compounding effect on my investments.
After following this approach for a number of years, I’d hope to build a sizeable portfolio that could provide me with a second income in later life.
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.
