Is It Realistic To Retire Off Dividend Income?
If anyone is seeking to retire off dividend income you have come to the right place.
So, is it realistic to retire off dividend income?
Yes, it certainly is.
How does it work?
When you own a stock that pays dividends, you’re essentially earning passive income.
Dividends are a portion of a corporation's profit that they pay out to their shareholders. Dividends are payments made by a company to you as a reward for owning a share in the company.
But could you eventually use them to fund your lifestyle in retirement? That would be the game-changer.
How much money do you need to Invest to live off dividends?
The formula:
Annual Income You Want/ Dividend Yield= Amount You Need Invest
So you would need to consider how much annual income you want to live off retiring and divide it against the average dividend yield in your investment portfolio to find out how much lump sum you need to be invested to live off your dividends fully.
Example
For example, plan to spend $40,000 a year to support yourself and your family in the future. If you believe you could achieve a portfolio with a dividend yield of 3%, divide $40,000 by 3% to find a minimum portfolio value of $1,333,333.
$40,000 / 0.03 = $1,333,333
How do you get started?
Everyone’s income needs are different.
The easiest way to do this is by looking at what you earn from working today. You then divide it against your average dividend yield in your stock portfolio.
Your stock portfolio’s total dividend yield would depend on your stock composition. Oftentimes, you may own a variety of individual stocks, and ETFs with different dividend yields.
Here are some examples of some average dividend yields on some popular investments for your reference:
- Vanguard S&P 500 Index Fund ETF: 1.69% long-term average.
- Ford Stock: 5.01% average over the last five years.
- Schwab US Real Estate Investment Trust (REIT) ETF: 2.69% over the last five years.
To find the dividend yield, look at the historical dividend yields for any given asset. This isn’t a guarantee of what you’ll earn, but it will give you an idea of what it might pay out in the future.
How realistic is it to live off dividends?
The goal would be to have dividend income replace your day. Once you reach that goal, you free up your days to pursue your interest and passions which may even provide you with additional income.
How much you need really depends on:
- Your standard of living.
- The dividend yield on investments (Risk tolerance on invested investments).
Example 1:
Higher risk tolerance
Ben is a single person who spends $48,000 to support himself each year in an area of California with a relatively high cost of living. He has a high-risk tolerance and invests more heavily weighted toward equities that contain plenty of REITs with high dividend yields.
He expects his retirement portfolio to pay a dividend yield of 6% per year. $48,000 divided by a 6% yield means he’ll need to invest about $800,000 to live off dividends.
$48,000 / 0.06 = $800,000
Example 2
Lower risk tolerance
David and Anna are a married couple living in Texas. After their children move out, they expect it will cost them about $40,000 to support themselves. They’re relatively risk-averse and want to focus on maintaining a simple life. As a result, they create a portfolio that will have a dividend yield of around 2%.
$40,000 in annual spending divided by a 2% dividend yield means they’ll need to invest $2,000,000 to live off dividends.
$40,000 / 0.02 = $2,000,000
Tax implications
Taxes are due in the year dividends are received.
Dividend taxation is complex. And everyone’s tax situation is different. You may want to consult a tax advisor if you are in doubt.
With a traditional retirement account, you won’t pay taxes on dividends while you reinvest them. Once you start taking them as distributions, though, they’ll be taxable at ordinary income rates
For non-US residents, non-resident aliens are subject to a dividend tax rate of 30% on dividends paid out by U.S. companies. The 30% tax rate can also be lower depending on the treaty between your home country and the U.S. Hence you will want to confirm this with your brokerage account.
Conclusion
Understanding how dividend income works could be a starting point for you to potentially live off dividends income up to a point it completely replaces your day job.
Lastly, enjoy the journey and have fun. This journey should be exciting for you to know you are working closer to financial freedom day by step. So really go out there and make things happen.
“If it is to be, it is up to me.”
― William Johnsen
