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The dividend tax threshold has been coming down over the last few years. But for those who can avoid this by using an ISA, £20,000 can generate a lot of passive income.
With interest rates at 4.5%, it might be tempting to look for income outside the stock market. Over the long term, however, I think UK investors stand to do better with dividend shares.
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.
Why UK shares?
I always look to invest in the best opportunities I can find, regardless of which exchange they’re listed on. But with dividends, there are advantages to focusing on UK shares.
The most obvious is tax – distributions from companies outside the UK are subject to withholding taxes. In the case of the US, this is 30%.
That can be reduced to 15% with a W-8BEN form, but that’s still enough to turn a 4% dividend yield into a 3.4% dividend yield. And investors have to factor this into their calculations.
If a US company is good (or cheap) enough, it could absolutely offset this cost. But UK shares have an immediate advantage for investors looking for passive income in an ISA.
A five-stock portfolio
Investing £20,000 to earn £1,000 per year implies a 5% dividend yield. And with UK shares prices where they are, I think that’s highly achievable.
An example portfolio could look like this:
| Stock | Dividend yield |
|---|---|
| Admiral | 5.30% |
| Croda International | 4.20% |
| Diageo | 3.9% |
| Primary Health Properties | 7.20% |
| Tesco | 4.40% |
| Average | 5% |
Investing £4,000 into each of these stocks could generate £1,000 per year in dividends. And there’s always the option to reinvest those dividends to earn more income in the future.
The stock with the highest dividend yield is Primary Health Properties (LSE:PHP). In general, I’m wary of stocks with unusually high yields, but this one is a rare exception.
Real estate income
Primary Health Properties is a FTSE 250-listed real estate investment trust (REIT). It makes money by owning and leasing GP surgeries throughout the UK (and a bit in Ireland).
As a REIT, the company has to distribute 90% of its rental income to investors in the form of dividends. And with most of its rent coming from the government, it’s been very reliable.
One thing real estate companies want to avoid is vacancies, but demand for GP surgeries has generally been strong. And people living longer means this could well be a durable trend.
I think growth is likely to be steady, rather than spectacular. But with a dividend yield of 7.2% investors might well feel there’s enough to generate a good return without big increases.
Diversification
Given this, a natural question is why not just buy Primary Health Properties and forget about the other stocks? The answer is that – as with all shares – there are risks with the business.
The biggest potential issue is the fact the firm’s debt is higher than its market value. So if it has to pay this off, the dividend per share could fall significantly.
Even if this happens, I don’t think the stock will turn out to be a terrible investment. But it’s why investors should consider it as part of a diversified portfolio, rather than by itself.
