With the State Pension age set to rise further over the long run, having an alternative income in older age may become increasingly important. Furthermore, the State Pension may be insufficient to provide financial freedom in retirement, which could make a passive income even more worthwhile.
Of course, many people have sought to generate a second income through saving in a Cash ISA, or by taking more risk through having a buy-to-let investment. While both of these opportunities have delivered high returns in the past for many people, in future they may fail to match the opportunities that are currently on offer within the FTSE 100.
Tax changes
Cash ISAs and buy-to-let investments have lost much of their appeal from a tax perspective over the last few years.
Cash ISAs, for example, are less attractive relative to a bog-standard savings account because the first £1,000 in interest income received outside of a Cash ISA is tax-free. Since interest rates are low, and a 1.5% return is likely to be the best savers can hope for at present, an individual would need to have £67,000 in a Cash ISA in order for it to pay interest of over £1,000 per year. As such for many people, a savings account offers the same tax benefits as a Cash ISA.
Similarly, buy-to-let investments are becoming less appealing from a tax perspective. There’s now a stamp duty surcharge of 3% on second homes. Interest paid on mortgages can also no longer be offset against rental income for many landlords, which could reduce their overall returns at a time when rental rises may slow as a result of an uncertain outlook for the UK economy.
Return potential
With interest rates forecast to remain at historic lows over the medium term, the prospects for savers continue to be challenging. Likewise, house price growth has slowed across many parts of the UK, which could lead to lower returns than many landlords have been used to in recent years.
By contrast, the FTSE 100 continues to offer an impressive long-term outlook. It currently yields over 4%, which suggests it offers good value. There are also a number of companies that have solid track records of dividend growth, and which have generous dividend cover. This could mean they are able to offer inflation-beating dividend growth over the coming years.
Furthermore, shares purchased in a Stocks and Shares ISA continue to be tax efficient. The rise in the annual allowance to £20,000 over recent years also means it’s possible for larger investors to take advantage of the tax benefits of investing in the stock market.
As such, with the State Pension continuing to lack appeal, now could be the right time to avoid buy-to-let investing and Cash ISAs. The FTSE 100 appears to offer a more favourable risk/reward opportunity for the long term.