Above the £500 allowance, basic rate taxpayers have to pay 8.75% on dividends. For someone earning £12,000 a year, that’s £1,006, but a Stocks and Shares ISA allows them to avoid this.
That can make a big difference to the amount someone needs to invest to collect £1,000 a month in passive income. And this is something investors shouldn’t underestimate.
Dividend yields
Interest rates in the UK are currently 4.25%. So I don’t think investors looking for dividend income should buy stocks that they don’t expect to provide a better return than this over time.
That’s not to say they shouldn’t consider something that’s going to offer less than this in the short term. One example I think’s worth considering is Unilever (LSE:ULVR), a stock with a current dividend yield of 3.15%.
Without the tax advantages of a Stocks and Shares ISA, to earn £1,000 a month in passive income someone would need to buy 8,891 shares. That involves an outlay of £417,523, which is a lot.
Using a Stocks and Shares ISA however, the required amount comes down to £380,952 – or 8,112 shares. That’s a significant reduction, but it would still take an investor years to get that into an ISA.
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.
Time
With stocks like Unilever however, there’s an advantage. The company’s increased the amount it’s distributed to shareholders as dividends consistently over a long time. Over the last decade, the rate of dividend growth’s been just over 5%. If this continues, investors who buy the stock today will be receiving twice as much per share 15 years from now.
That could bring down the amount of shares needed to earn £1,000 a month to 4,056. And at today’s prices, this would cost £190,476. That’s still more than someone could invest in a Stocks and Shares ISA in a year. But it shows that time can be a good substitute for cash when it comes to investing.
Growth
The big question, of course, is whether or not Unilever can continue to grow its dividend at that rate over time. And while there are no guarantees, I think there’s a decent chance of this happening.
As I see it, the biggest risk is the threat of competition. The company operates in an industry where customers can switch products easily and it has to contend with rivals with lower price points.
Investors shouldn’t forget though, that Unilever’s some important and durable strengths. These include its brand portfolio and the scale of its distribution network.
On top of this, the company’s been reducing its share count steadily over the last five years. And this should help it increase its earnings per share over time, even in a competitive environment. I feel it’s worth considering.
Passive income
The most important thing with investing is buying the right stocks and owning them for a long time. But not having to pay tax on dividends is a big advantage.
A Stocks and Shares ISA can make a big difference to an investor’s overall returns. And it can cut the amount someone has to invest to earn £1,000 a month in passive income significantly.
This post was originally published on Motley Fool
