Using Dividends for Retirement IncomeSubmitted by Mission Financial Planning on June 14th, 2020
While you are working, you add money to your investments to build a nest egg. In retirement, it’s time to start taking that money back out. The income goal in retirement is to mimic the paycheck you were receiving while you worked. This new “paycheck” often comes from several sources, including Social Security and/or pension payments, and perhaps rental income. Sometimes there is also a transition period after “retiring” of continuing to work part time. Dentists frequently work in their old practice, do locum tenens work, consult, speak or teach. Withdrawals from investments supplement these other income sources to reach the retirement income goal.
Retirement income withdrawals can be made up of bond income, stock dividends, and/or selling shares.
The closer you can come to covering your needed withdrawals with the bond income and stock dividends within a portfolio, the better. This means not having to sell shares to create income. Selling shares in a down market can have long-term implications for the sustainability of a portfolio. Dividends and income in a diversified portfolio these days might be around 3% - 3.5%. While many people need more income than just the dividends can provide, to know that this much can be withdrawn without selling investments is comforting.
In general terms, dividends are not affected by the ups and downs of the market. They are a piece of the company’s profits, sent to shareholders on a quarterly basis. Dividends can be cut, of course. When earnings are down, dividends can suffer. However, historically, dividend-paying companies avoid reducing them, and see cutting them completely as a last resort. Many Value-oriented companies have a track-record of consistently increasing dividends over time; these companies are very attractive to income-oriented investors. Some say that consistent income lends stability and resilience during volatile markets.
Dividends also provide a tax-advantage over most other income sources. When in an after-tax investment account, most dividend income is taxed at the capital gains rate (0%, 15%, or 20% depending on other income) rather than at ordinary income tax rates.
A retirement portfolio should be designed differently than one focused on long-term growth. Growth is still an important component for retirees, it helps them keep up with inflation, but usually the first priority is on how income will be generated. With dividends and bond income fulfilling most of the need for income, the need to liquidate shares can be minimized. As long as the stock’s growth is sufficient to cover what needs to be liquidated, the portfolio shouldn’t suffer. For times when the market is down, and liquidating would eat into principal, a cash reserve can come in quite handy.
When you need income from your investments you can access it in several ways: by having the dividends and/or bond income sent on a regular basis, taking judiciously-timed liquidations, and spending from the cash reserves. We recommend a balance, designed to produce a regular monthly deposit into your bank account, just like your paychecks used to be.
There are a number of things to consider when designing a withdrawal strategy, including which accounts to pull from for tax efficiency, charitable intentions, market conditions, etc. Keep an eye on blog posts tagged with Withdrawal Strategy to learn more.
Set up a time with us to discuss your retirement income strategy.