UK Markets closed

Retirement savings: I’d buy 5%+ FTSE 100 dividend shares in an ISA to make a passive income

Peter Stephens
Lady researching stocks

At the present time, it may be possible to build a diverse portfolio of FTSE 100 shares that offers a combined dividend yield in excess of 5%.

After all, the index has a relatively high yield compared to its historic average, and around a quarter of its members yield over 5%.

As such, the FTSE 100 could offer the means of making a generous passive income in retirement. That’s especially the case when retirees consider their other options, such as bonds and cash, which offer historically low income returns in many cases at the present time.

FTSE 100 income opportunities

Despite experiencing a decade-long bull market, the FTSE 100 continues to trade at levels that could indicate it offers good value for money. Certainly, its dividend yield of 4.5% is relatively high at the present time. This could mean that retirees can purchase a range of large-cap shares in a tax-efficient account, such as a Stocks and Shares ISA, to enjoy a passive income that is in excess of 5%.

Furthermore, there are prospects for FTSE 100 companies to raise their dividends at a faster pace than inflation over the coming years. Since the index generates around two-thirds of its income from non-UK economies, it may be able to access the faster growth rates of a range of emerging economies. In turn, this may raise the scope for inflation-beating dividend growth that further widens the gap between the income returns on FTSE 100 companies and other assets.

Relative investment appeal

While investing in buy-to-let property, holding bonds or having some cash have all been attractive investment options for income investors in the past, today they appear to be unappealing. Cash and bonds, for example, offer minimal real-terms returns due to interest rates being close to their historic lows. Buy-to-let investments, meanwhile, could offer falling net returns as tax changes and higher house prices squeeze the income appeal of the sector.

Therefore, retirees who are aiming to generate a passive income from their capital may be better off accepting short-term volatility from the stock market in return for a significantly higher yield.

Although risks such as a UK general election and geopolitical risks in countries such as Hong Kong may weigh on investor sentiment, the long-term track record of the index shows that it has always been able to recover from its downturns. And by selecting those companies with solid histories of paying dividends through turbulent economic periods, investors may be able to increase their chances of obtaining a consistent income return over the coming years.

Accessing high income returns

With it being easier and cheaper than ever to open a Stocks and Shares ISA online, accessing the FTSE 100’s income potential is an available option for almost anyone. While its risks may be higher than other mainstream investments, the 5%+ income return that is on offer from large-cap shares could make it a worthwhile buying opportunity for retirees who are seeking to generate a passive income in older age.

More reading

Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019