What makes a Stocks and Shares ISA a potentially useful vehicle for generating passive income?
Several things, in my view. As I explain below, with the right approach, an ISA can end up providing some powerful passive income streams.
Why bother with an ISA?
Some passive income ideas are pretty whacky. Some are not passive at all, but involve a fair bit of work.
By contrast, investing in the shares of proven blue-chip companies that pay dividends from spare cash they generate can potentially provide income that is genuinely passive. I say “potentially” because dividends are never guaranteed. But by spreading the ISA across a range of different, carefully-chosen shares, I think that risk can be managed.
Still, that approach does not require an ISA. A simple share-dealing account or trading app would suffice. However, an advantage of a Stocks and Shares ISA is that dividends can pile up in it free of tax.
By taking a long-term approach, those can be reinvested (compounded) so that dividends can end up generating more dividends over time.
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.
Five-figure passive income potential
As an example of how lucrative this could be, say that someone compounds their Stocks and Shares ISA at 7% annually. After 35 years, it ought to be big enough that a 7% dividend yield would equate to £14,947 a year of passive income.
That raises two questions though: why wait so long and is a 7% target realistic?
A long-term approach can pay rewards
Waiting 35 years gives compounding enough time to make a real financial impact. That is why the passive income is so impressive.
But it is not necessary to wait 35 years. The same approach could work on a much shorter (or longer) timeframe. However, the income earned would be correspondingly different, based on the timeframe.
Hunting for high-quality shares to buy
What about a 7% target compound annual growth rate and, later, dividend yield? (By the way, the difference is that the compound annual growth rate includes not only dividends but also any capital gain, less any capital losses). I see 7% as realistic.
One share I think investors should consider is ITV (LSE: ITV). It aims to pay out at least 5p per share in dividends annually. At the moment, the share sells for pennies, so its dividend yield is 6.1%. That means for every £100 invested, an investor will hopefully earn £6.10 annually in dividends.
On top of the income opportunity, I also see some potential for the ITV share price to grow over time. That would be a change from what we have seen in recent years. Over the past five years, the share has lost 31% of its value.
Such a fall reflects a risk that remains of concern: the impact of growing digital rivals and changing media consumption trends on a legacy broadcaster.
I recognise that as a risk. But ITV’s legacy business remains a strong foundation for its business, even if it is set to decline over time.
The company has been developing its digital business too. It also has a sizeable production business providing studio space and expertise. To me, the current share price undervalues the long-term value of that combination.
