Generating passive income doesn’t have to be complicated. It can be as simple as investing in UK company shares in a Stocks and Shares ISA, then sitting back as the tax-free dividends accumulate over time.
To give an example, let’s assume an investor wants to aim for an average of £700 each month in passive income. How would they get there? Let’s take a look.
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.
The yield
When an investor puts money into a company for dividends, they will obviously want to know the expected income return. That can be worked out by looking at the stock’s dividend yield.
Take blue-chip bank HSBC (LSE: HSBA), for instance. It currently sports a 6% yield, which means investors would be looking to receive £60 in annual dividends from every £1,000 they invest.
However, dividends are paid at the discretion of the company, meaning the sum could end up lower or higher. In an extreme case (such as another pandemic or financial meltdown), there might be no shareholder distribution at all.
£700 a month
Let’s stick with that 6% figure and use it for the example here. An ISA portfolio yielding 6% would need to be worth £140,000 to throw off £8,400 a year (the equivalent of £700 a month).
Unfortunately, that’s not the sort of cash most people have down the back of the sofa. Moreover, it far exceeds the annual contribution limit of £20,000 for a Stocks and Shares ISA.
Therefore, an investor would need to build up to that amount over time. How long that takes, of course, would be down to how much they invested and the rate of return.
If they invested £550 a month, it would take them just under 14 years to reach £140,000. This assumes a 6% return and the initial reinvesting of dividends to build up the portfolio’s value.
For someone able to max out the full annual ISA limit (£1,666 a month), it would take less than six years.
Banking goliath
Returning to HSBC, I think it’s a FTSE 100 dividend share worth considering. Even after a strong recent performance that has put the share price close to its highest level since the turn of the Millennium.
Last year, the bank reported that pre-tax profit rose 6.6% to $32.3bn, ahead of analysts’ expectations for $31.7bn. It also announced a new $2bn share buyback, which it plans to complete by April.
In recent years, HSBC’s been retreating from mature Western markets to focus more on a growing Asia. While I think that strategy will pay off long term, it does present risks, especially as China’s economy can be unpredictable. This can translate into volatility in both earnings and the share price.
In terms of income though, I think this is a solid stock. The proposed payout’s covered almost twice over by forecast earnings, which provides a nice margin of safety. As a shareholder myself, I’m also hoping for further share price gains in future.
Again though, no dividend is assured. So it’s important to build a diversified portfolio of quality dividend stocks to target passive income.
