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Passive income is the ultimate goal for many investors, and investing via a tax wrapper can accelerate the journey. Britain has two great options, the Stocks and Shares ISA and Self-Invested Personal Pension, better known as a SIPP. Both shelter dividends from tax, but in slightly different ways. So which works best for income-hungry investors?
I’d never rely on artificial intelligence to pick shares, but I wondered whether AI could help untangle a technical question like this. So I asked ChatGPT.
Two ways to shelter dividends
The chatbot told me a SIPP offers immediate tax relief on contributions, which gives income investors a head start. A basic-rate taxpayer investing £8,000 gets that topped up to £10,000, while higher-rate taxpayers can reclaim another £2,000 through their self-assessment tax return. That larger pot buys more stock from day one, which means more dividends.
However, pension money is locked away until at least age 55, rising to 57 in 2028. And while 25% can usually be taken tax-free, the rest is taxed as income on withdrawal. For anyone hoping to live off dividends before retirement, that restriction matters.
ISAs turn that tax equation upside down. There’s no upfront boost, but all dividends and gains are free of tax for life and can be taken whenever needed.
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.
M&G is a high-yield star
One UK dividend stock I’m more than happy to hold is FTSE 100 wealth manager M&G plc (LSE: MNG). I bought it in 2023, mainly for income, when the yield was close to 10%. The shares have surged 47% over the past year, giving me a nice chunk of growth too. Sadly for new investors, that’s pushed down today’s trailing yield down to 6.5%. Still attractive though.
The board has steadily increased dividends but the pace of growth should slow to a modest 2% a year. At least payouts should be sustainable, as M&G boasts a solid Solvency II ratio of 234%.
The shares have had a strong run and may slow from here, especially if we get a burst of market volatility. A crash would hit asset values and could dent capital buffers, although M&G has a decent cushion. Last month, the board warned of a one-off £230m reduction in Solvency II Funds linked to the government’s proposed cap on ground rents. That’s a blow, but hardly disastrous.
Even if the yield isn’t quite as fabulous as it was, M&G shares still look worth considering for long-term income investors. So what about that ISA/SIPP question?
ChatGPT didn’t declare a single winner. It said while a SIPP delivers that valuable upfront boost, holding high-yield shares inside an ISA has the huge advantage of keeping every penny of income free from tax. I’d argue that this makes life a lot simpler for those making regular withdrawals, year after year.
A combination of the two is probably ideal, because the tax breaks are complementary, but there’s an argument for putting more of the income generating ones into an ISA. Like everything to do with investing, it’s a personal decision, and chatbots can only provide a very artificial answer.
