Retirement is the beginning of a new phase of your life. However, to ensure you are financially secure during the later years of your life, you must make the right investments and undertake failproof retirement planning. As an investor, it is important to select investments that have the potential to give you a safe and secure retired life. During the early stages of retirement planning, you generally invest aggressively in stocks to earn high returns, even if they come with a higher level of risk. However, as you approach your retirement age, your investment strategy shifts from being aggressive to conservative. Instead of investing in stocks with high risk and high return potential, you start focusing on low-risk, moderate return securities like bonds, etc.
After years of consistent retirement planning, when you finally retire, your investment strategy alters again. Now, your sole focus is on ensuring your accumulated retirement corpus lasts your lifetime. To avoid the risk of outliving your savings, you center your investments for capital preservation rather than growth. Living off your savings during retirement is often more challenging than saving for a comfortable retirement. Further, rising life expectancies, low bond yields, growing stock market volatility, etc., have made it difficult to build a stable retirement income stream.
Before finalizing your portfolio for sustaining your retirement expenses, you need to understand how much risk you are willing to take and how much return you require to maintain a reasonable quality of life during retirement. One way to augment your retirement income is to invest in dividend-growth stocks, mutual funds, and exchange-traded funds (ETFs). Dividend growth investing can help you supplement your Social Security benefits and pension earnings in retirement. If invested wisely, a dividend retirement portfolio can be sufficient to sponsor all your retirement needs. However, when creating such a portfolio, you should be careful of specific aspects. As a retiree, it may not be advisable to forgo the growth aspect. An ideal dividend retirement portfolio for retirement income should be a combination of dividend-paying and dividend-growth investing stocks. Stocks that pay regular dividends with growth potential are a wise investment for a retirement portfolio that aims to generate a regular income. To find out more about which dividend-paying and dividend-growth investing stocks would be suitable for you, get in touch with a professional financial advisor. A qualified advisor would be able to suggest the right stocks for you to invest in that can help you create a steady retirement income stream in your golden years.
Here is everything you need to know about creating a dividend portfolio for retirement income:
A dividend portfolio is one where you buy stocks of companies that pay steady dividends. When you buy a stock, you become a proportional owner of that company depending on the shares you own. When the company makes profits, it has three choices for utilizing the excess cash. The company can retain the profits, use them for research and development, or distribute them to shareholders as dividends.
These dividend payments can act as a regular and stable income source during retirement. Dividend income is like earning interest from a bank savings account. If you own one share worth $100 in a company that pays a 6% annual dividend, you will get $6 each year as dividend income. The greater the number of shares, the higher is the dividend income. So, if you hold 30 shares in the same company, your yearly dividend income will be $180.
Apart from earning income through regular dividends, you also benefit from a rise in the value of your stock investments. Stock prices rise over time, making your shareholdings more valuable. This increase in value is known as capital appreciation. This is one reason why financial experts recommend investing in dividend growth stocks.
Companies pay dividends every quarter to shareholders per the type of their shareholding. If you own preferred shares in a company, you receive fixed-rate dividends. However, if you are a common shareholder, your payouts are variable.
Dividend investing can help provide an assured source of retirement income. Moreover, a dividend investing strategy helps preserve your capital over a long tenure and generate a growing income in retirement irrespective of the market conditions.
For instance, assuming you retire with $1 million as your retirement corpus, you require $40,000 per month to maintain your retirement standard of living. The rate of inflation is 2%, and bond yields match the inflation rate. Your stock dividends grow at 3.5% each year.
Now, you invest $400,000 in bonds and $600,000 in stocks that pay an annual dividend of 3%. Your dividend retirement portfolio generates $18,000 income per year. This is insufficient to cover your retirement income requirement of $40,000. Hence, the balance is substituted by the bond yields.
After you spend all income from your dividend retirement portfolio in a year, you sell your bond portfolio to get the inflation-adjusted $40,000 per month in retirement. In 21 years, your bond portfolio will be depleted. However, during this period, your inflation-adjusted dividend income will grow to $24,000 per year, and you will still own your stocks.
Further, if your dividend income grows every year, there is sufficient reason to believe that the value of stocks has also risen, leading to capital appreciation. This will give you a stable income source during retirement and a healthy retirement nest egg.
Even though your primary stock and bond portfolio structure depends on your risk tolerance, financial objectives, and time horizon, building a dividend portfolio for retirement income that yields 3% or higher per year and grows at 3.5% or more per year is a wise strategy. That said, given the low interest rates today, it is possible to construct a 4-4.5% dividend portfolio for retirement income while maintaining your risk preferences, portfolio diversification, and income security.
Apart from offering a stable retirement income, a dividend retirement portfolio also provides valuable tax benefits for you as an investor. As per the IRS (Internal Revenue Service), all dividend incomes are not subject to the same tax duties. For taxation purposes, the IRS divides dividends into two categories – qualified and non-qualified. Qualified dividends are given preferential tax treatment and charged at a lower long-term capital gains tax rate. Depending on your tax bracket, this means you can expect to pay anywhere between 0-20% as taxes on dividends received. However, non-qualified dividends are taxed as regular income. The range for ordinary income tax is between 10-37% plus a 3.8% additional tax for specific investment income for high earners.
Dividends paid by U.S. companies are considered qualified dividends. So, if you hold your stock investments for 60 days, your dividends are taxed as long-term capital gains. Dividends from stock investments in Master Limited Partnerships (MLPs) and real estate investment trusts (REITs) are taxed as ordinary income. Further, investments like money market funds, cash instruments, etc., are classified as non-qualified dividends and taxed as regular income.
Dividend growth stocks held in tax-advantaged retirement savings like a 401(k) or an IRA (Individual Retirement Account) are not subject to any taxes until you withdraw your funds. However, investing in MLPs can have tax implications even if you invest through your IRA.
Here are some of the top benefits of using a dividend portfolio for retirement income:
Even though a dividend portfolio for retirement income is a smart strategy, it is wise to be aware of the drawbacks of this strategy to ensure you make the right decision for your financial security.
Here are some disadvantages of using a dividend income strategy:
If you want to use a dividend retirement portfolio for generating a stable income, you can consider implementing any of these three strategies:
No retirement income strategy comes with a guarantee. However, a dividend retirement portfolio customized to suit your requirements can prove to be an effective strategy for retirement. By investing in quality dividend stocks and balancing them with small-cap dividend growth stocks with increasing payouts, all types of investors can benefit from the strategy. Moreover, with some detailed planning, it is possible to live off your dividend income stream during retirement. Consult a professional financial advisor to help you choose the right stock investments and create a dividend retirement portfolio aligned with your needs, financial goals, and investment horizon.
To get in touch with a qualified financial advisor, use Wiser Advisor’s free advisor match tool. Our free match services connects you with 1-3 background-verified financial fiduciaries. You may also set up a free initial consultation with them before deciding to hire one.
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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.