Taking full advantage of the annual ISA contribution allowance to buy armloads of dividend shares could be a lucrative long-term passive income plan.
How lucrative? Let’s find out!
Starting with intent
To begin, I presume that someone puts their full annual contribution allowance into a Stocks and Shares ISA.
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Typically that is £20k per year, so over five years that ought to add up to £100k.
There can be fees and commissions that eat into that money even when it is sitting idle, so it pays to compare the options when looking for a Stocks and Shares ISA to use.
I realise that for many of us, £20k per year is a lot to invest. The same approach could work on a smaller scale, producing less income.
But I think it can be worth starting with strong intent to build serious passive income streams.
Time and dividend yield both matter
How much that will earn depends on dividend yield and timeline.
To start with, dividend yield is the annual passive income earned through dividends, expressed as a percentage of the cost.
For example, at a 5% yield, £100k could earn £5k annually. That is the straightforward result of fully utilising the ISA allowance for five years, then pulling out all dividends as passive income.
But deferring gratification, compounding (reinvesting) dividends along the way could increase the ultimate size of the passive income streams.
Say someone puts in £20k annually to their ISA for five years, compounding dividends, then stops putting money in but keeps compounding. After a decade, the ISA would be big enough (around £110k) to earn around £5,520 in passive income annually.
If they wait another five years and keep compounding along the way, the ISA ought to be worth around £141k – enough to earn annual passive income north of £7k.
Or, compounding for another decade beyond that, the ISA ought to be just short of £230k in size. At a 5% yield, that could produce annual passive income of around £11,487.
Here’s a passive income share to consider!
This is not just academic to me – I already earn passive income from some shares I own.
One is Domino’s Pizza (LSE: DOM). The UK master franchisor of the global pizza giant yields 6%.
However, above I said that yield is a function of dividend per share and share price. Domino’s yield partly reflects its share price more than halving over the past five years. Ouch!
Clearly, then, there are risks. The UK pizza market may have reached saturation point, chicken is replacing pizza in some customers’ affections and food inflation could eat into profit margins.
For investors willing to stomach such risks, though, I see the FTSE 250 share as worth considering. Domino’s is well-known and has economies of scale.
The business is proven and its own expanded chicken offering could help protect the business as consumer tastes shift.
