The Stocks and Shares ISA is the perfect vehicle to generate passive income. In this account, both returns and dividends are not subject to tax.

But with the annual allowance capped at £20,000, how much sustainable passive income can someone realistically expect to get from an ISA? Let’s take a look.

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Dividend yield

Scanning the FTSE 250 today, I see six stocks with dividend yields above 9%. Indeed, two of them offer over 10%!

Were someone to invest £20,000 equally into these six mid-cap shares, they could hope to get back about £1,900 each year in dividends. That would be some return.

Problem is though, high yields like this are normally red flags. They suggest that the market thinks a dividend cut is looming on the horizon.

Digging a bit deeper, this is indeed the case, with the two highest yielders — Partners Group Private Equity and TwentyFour Income Fund — recently announcing dividend cuts. This proves that the headline yield is never entirely safe.

Therefore, it can dangerous to buy stocks that carry ultra-high yields without checking why they’re so high in the first place.

Are the firm’s debt interest payments soaring? Is its industry (housebuilding, say) facing some cyclical pressure? Has the price of a commodity that drives profits — gold or lithium, for example — crashed?

These are all questions that need to be asked when looking at an individual dividend stock with a high yield. This is why a yield is only the starting point for further research, not the be all and end all.

A high-quality stock

For me, the sustainability of the dividend over time is crucial. That’s because a 3% yield growing at 10%+ a year can comfortably deliver a better return over the long run than a 6% yield growing at 2%.

One FTSE 100 stock that I think could deliver compounding dividend growth over time is Next (LSE:NXT). The retailer has raised its profit guidance three times so far this year, and now expects pre-tax profit of £1,255m for FY27.

The firm’s digital sales are growing quickly, especially overseas where its multi-brand offerings are increasingly popular. In the first half of FY27, online international sales jumped 23.9%.

Longer term, it also has a large opportunity to expand stateside, but digitally and asset-light, not by opening brick-and-mortar stores. The Middle East is another growth market.

Turning to the dividend, Next upped its payout by 15% to 268p last year. In the first half of this year, it increase its interim dividend by 12.6%. So while the forward yield might look paltry at about 2.4%, it’s growing by double digits.

Moreover, last year’s payout represented 36% of Next’s post-tax profit and the dividend cover was 2.8 times. This suggests to me that the payout is safe and that there’s plenty of scope to increase the dividend over time.

Aiming for higher

Of course, Next could face challenges if inflation worsens and tax rises happen at next month’s budget. UK sales could take a hit and dividends are never guaranteed.

But I think the stock is worth considering as part of a quality diversified portfolio that contains higher yielders too.

Were the overall £20k ISA to yield 5% — a realistic target, in my opinion — it would generate £1,000 per year in tax-free passive income. With the potential to grow over time.

Should you invest £5,000 in Next Plc right now?

When investing expert Mark Rogers and his team have a stock tip, it can pay to listen. After all, the flagship Twelfth Magpie Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.

And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Next Plc made the list?

Ben McPoland has no position in any of the companies mentioned.