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A Stocks and Shares ISA is a valuable asset for investors looking to earn passive income. In fact, it’s become even more so after the Autumn Budget.
The contribution limit stays at £20,000, but dividend taxes are going higher for investors in the basic and additional rate brackets. And the difference might be more than you might think.
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.
A £20,000 investment
From April, basic-rate taxpayers are set to pay 10.75% on dividends above £500. So someone who invests £20,000 in a portfolio yielding 5.5% wil pay £64.50 on £1,100 in annual dividends.
That doesn’t sound like much, but it adds up to £1,935 over the life of a 30-year investment. And the situation is worse for someone who wants to grow their income by reinvesting.
The £500 dividend allowance stays fixed as a portfolio grows, so investors don’t just pay more tax. They actually end up losing a higher percentage of their passive income.
As a result, a basic-rate taxpayer who starts with £20,000 and reinvests at 5.5% for 30 years ultimately ends up paying £5,493. But this isn’t the only cost.
Investors who use Stocks and Shares ISAs don’t just save that tax. They also get to reinvest it, to give their dividends an additional boost with the cash they save in taxes.
The difference over 30 years is huge. Instead of £3,776 a year from a taxable account, an investor who uses a Stocks and Shares ISA can earn up to £4,668 in annual passive income.
A 5.5% yield
I’ve been focusing on a 5.5% return in the calculations above. And that’s because there’s a dividend stock with that yield that I think is worth considering right now.
The stock is Admiral (LSE:ADM). It has a lower dividend yield than some other UK insurers, such as Aviva or Legal & General, but I think the corresponding risks are also much lower.
Car insurance is a good industry and a bad industry. It’s good because it’s non-negotiable – anyone who wants to drive has to buy insurance from somewhere.
It’s bad because it’s mostly a commodity. Customers just go wherever the cheapest price for the cover they need is on offer and there isn’t much companies can do about this.
Admiral, though, has a unique advantage. Its telematics products give it better data about drivers, allowing it to assess risk more accurately and maintain higher margins.
In any given year, premiums can fall if competitors price contracts too low. But this isn’t sustainable and Admiral’s better data gives it a key long-term advantage.
Dividend investing
Admiral is the kind of stock I think income investors should consider in the portfolios. But there are other companies that also have strong positions in important industries.
The ultimate ambition has to be to build a diversified portfolio. And I think UK investors can do this while maintaining a 5.5% overall dividend yield.
An important part of the process, though, is taking advantage of opportunities like Stocks and Shares ISAs. There’s no point earning a big return if you have to give it away in tax.
