Could an ISA stuffed with dividend stocks be a lucrative source of passive income?

I bet you do!

Of course, there is no guarantee that this will happen. It depends on which shares the investor chooses and how they will behave in the future.

However, I believe that with careful selection of a diversified range of shares ISA, an investor could potentially turn an ISA into a long-term passive income machine.

Rolling the ball

Let’s imagine someone makes a standard annual ISA contribution of £20,000. pounds into a Stocks and Shares ISA for each of the next five years (assuming this allowance remains unchanged).

Please note that tax treatment depends on each client’s individual situation and may change in the future. The content of this article is for informational purposes only. It is not intended to be and does not constitute any form of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.

How much will they have after five years?

After inserting 100 thousand pounds, the obvious answer may seem to be 100,000. pounds.

But they say they invested the money in dividend stocks and reinvested the dividends along the way. Taking into account, say, 7%, the ISA should be worth around £115,000 after five years. pounds.

While there may be money coming in (from dividends), there may also be money going out (from commissions, transaction fees and charges).

So an experienced investor will take the time to carefully choose the best Stocks and Shares ISA for them.

Looking to the future

What then?

One way would be for the investor to continually raise the dividend year after year, or even decade after decade.

This can be very profitable in the long run.

But while I’m an advocate of long-term investing, I realize that some people want passive income sooner rather than later.

So in this example, an investor could invest for five years and then start withdrawing the money as passive income.

Even if they don’t contribute a penny to their ISA, it should generate annual dividend income of around £8,051.

Choosing the right dividend stocks

This also assumes a profit of 7% as previously in my example.

But now FTSE100 the leading stock index yields 3.1%. So is my goal too ambitious?

I don’t think so. After all, this average rate of return covers 100 different companies, and some of them don’t even pay dividends. I think a 7% return is realistic in today’s market, depending on your investment choices. Some stocks yielding less than 7% may be offset by some higher yielding stocks.

One stock I think investors should consider for its passive income potential is the FTSE 100 cigarette maker British-American tobacco (LSE: BATS).

Stocks yielding 5.6% have increased their dividend every year for decades. This reflects the robust cash generating characteristics of its business.

The cigarette market remains immense, smokers can accept regular price increases and they like British premium brands Happy Stroke give it pricing power.

There are still challenges. The number of cigarette smokers is likely to continue to decline. Cigarette sales volumes in British America are withering significantly.

However, it can employ its pricing power to mitigate such volume declines. Moreover, the company has developed a non-cigarette business that could assist it maintain or even raise revenue in the coming years.