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It might not sound like much, but investing just £99 a month in a Stocks and Shares ISA could eventually build into a decent passive income stream. With the right FTSE 100 dividend shares, regular contributions and a bit of patience, a modest monthly investment could one day pay out the equivalent of the State Pension — essentially doubling retirement income.
A Stocks and Shares ISA allows investors to put up to £20,000 a year into shares without paying tax on dividends or capital gains. That makes it one of the most efficient vehicles for long-term wealth generation in the UK.
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.
Calculating returns
When it comes to building passive income, the key is yield. Many reliable FTSE shares offer dividend yields ranging from 5% to 9%, depending on the sector. Picking the highest yields seems logical, but diversification is key to reducing risk.
By combining dependable mid-range yields with a few higher-risk, high-yield picks, an average of 7% is possible. That’s a solid foundation for long-term growth. Ideally, pick shares with 10 years of consecutive annual dividend growth at a rate of 5% or more.
Now consider the maths. Start with an initial £1,000 savings and add £99 a month. Assuming dividends are reinvested and the portfolio grows at the above rate, the pot could reach over £23,000 in 10 years. At a 7% yield, that would generate over £2,000 in annual income.
Keep compounding for another 10 years and the pot could grow to over £100,000, producing annual dividends of around £12,770. That’s over £1,000 a month, a handy boost to add to the UK State Pension.
Keep in mind though, dividends are never guaranteed and can be cut or reduced at any time.
So what shares might help achieve this?
Good dividend stocks tend to have a few things in common: a respectable yield, a reasonable payout ratio, years of consistent dividend growth and strong free cash flow. Low debt levels and stable operating margins are also worth watching. Think Phoenix Group, LondonMetric Property and National Grid — all companies that offer steady income and solid fundamentals.
But one of my favourites for long-term income is British American Tobacco (LSE: BATS).
Yes, it’s a controversial stock from an ethical standpoint, but from a purely financial perspective, it ticks many boxes. The company has been investing heavily in next-generation products like vapour and heated tobacco to reduce its reliance on traditional cigarettes.
It has also increased its dividend every year for over two decades, with an average annual growth rate of 5%. The current dividend yield is 6.8%, and the share price is up 40% in the past year – that sounds like a stock worth considering for an income portfolio.
Decent value with some risk
Of course, there are risks. Regulatory pressure, health campaigns and smoking bans could impact future growth. Innovation in non-combustible products may not fully offset declines in traditional sales but, for now, it remains a strong income play.
Valuation-wise, it trades on a slightly high price-to-earnings (P/E) ratio of 26.4 but has a decent debt-to-equity (D/E) ratio of 0.74. Plus, it has solid profitability metrics, including a free cash flow margin of 31.4% and an operating margin of 14.6%.
For those aiming to turn small monthly contributions into a substantial passive income, dividend shares like BAT could make all the difference.
