How Much Money Do You Need to Live Off Dividends?

What is a Dividend?

“A dividend is the distribution of a portion of the company’s earnings, decided and managed by the company’s board of directors, and paid to a class of its shareholders. Common shareholders of dividend-paying companies are typically eligible as long as they own the stock by the ex-dividend date. Dividends may be paid out as cash or in the form of additional stock.” –Investopedia

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Are Dividends Taxed?

While you can find ways to live off dividends, it is important to keep in mind that the income you earn from dividends is taxable income. However, dividend income is taxed in different ways depending on whether the dividends are qualified or non-qualified.

  • Qualified Dividend: Dividends that are taxed at the lower long-term capital gains tax rate. 
  • Non-Qualified Dividend: Dividends that do not meet the qualified dividend requirements and are taxed as short-term capital gains. 

To be considered a qualified dividend, the dividend must be paid by one of the following:

  • A United States Owned Company 
  • A Company in U.S. Possession 
  • A Foreign Company Residing in a Country That Is Eligible for Benefits Under a U.S. Tax Treaty
  • A Foreign Company’s Stock That Can Be Easily Traded on a Major U.S. Stock Market  

In addition to meeting the above criteria, shareholders must all meet holding period requirements to be eligible for the qualified dividend tax rate. These holding period requirements state that the stock must have been held in excess of 60 days during the 121-day period beginning 60 days before the ex-dividend date.

The ex-dividend date marks the cutoff point that determines whether a shareholder will be entitled to receive the upcoming dividend paid out by a company. 

Overall, it is in a shareholder’s best interest to hold qualified dividends as the tax rate will be much lower compared to non-qualified dividends. In fact, qualified dividends are tax-free for individuals in the 10%, 12%, and 22% tax brackets or those individuals earning less than $80,000 per year.

Is It Realistic To Live Off Dividends?

Being able to live off passive income streams such as dividends would be a dream, but is living off dividends even realistic?

Before determining if living off dividends is a viable option, you will need to figure out your monthly living expenses. Of course, the monthly living expense of every individual is different. Therefore, the monetary value you will need to build your investment portfolio will vary significantly from person to person. However, to successfully live off dividends, your investment portfolio will need to be quite large. 

While it is attainable, the average person would need to build an investment portfolio of at least $1 million to fully cover all their living expenses. Let’s dive a little deeper into this figure below and examine the impact dividend yield will have on your ability to live off dividends. 

What is a Good Dividend Yield?

Whether a dividend yield is “good” or not is really in the eye of the beholder. For instance, whether a yield is good enough is based upon many factors, including how focused an investor is on capital gain potential, dividend growth potential, dividend safety, and more.

To help us understand this, let’s look at a few examples. For our first example, let’s assume a 25-year-old investor that has 40 years until they retire. This investor would do well to focus on dividend growth potential and companies that can stand the test of time in terms of dividend longevity.

These companies, however, tend to have lower current yields because investors bid up the stock’s valuation in anticipation of future growth. Thus, a yield of 1.5% or 2.0% may be deemed to be sufficient for this investor.

On the other end of the spectrum, let’s say we have an investor that is 65 years old and has just retired. This person is almost certainly not particularly interested in dividend growth potential and is likely much more focused on dividend safety and current yield.

Thus, this investor may have a “good enough” hurdle rate of 4%, or even 5% or 6% depending upon their needs.

Therefore, there is no “right” answer in terms of what dividend yield is good enough because the answer is different for every investor. One must take into consideration their portfolio size, their investment time horizon, their goals, their risk tolerance, and numerous other factors.

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How Much Do You Need to Invest to Live Off Dividends?

How much you need to invest to live off dividends is a function of your annual expenses and the dividend yield of your portfolio. Let’s look at some realistic examples of portfolios you could create to live off dividends in various scenarios.

Jack 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 is comfortable putting together a portfolio in retirement that’s more heavily weighted toward equities than bonds and contains 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

⚠️These numbers are, of course, estimates. You can never be entirely sure how much you’ll spend or exactly what dividend yield you’ll receive in the future. Both amounts can and will fluctuate, so make sure you build in a buffer according to your risk tolerance.

Jill is a single person in Florida and spends $30,000 a year to support herself in a city with an average cost of living. She also has a pretty average risk tolerance and is comfortable with a portfolio that has a weighted average dividend yield of 4%. $30,000 in annual spending divided by a 4% yield means she’ll need to invest about $750,000 to live off dividends. $30,000 / 0.04 = $750,000

John and Jane 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 more on wealth preservation than anything. 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

📘 Learn More: While inflation will probably increase your annual expenses over time, dividend payments tend to keep pace with it. To learn more about how inflation would affect your retirement, read this comprehensive guide to the concept: How Inflation Works: An Illustrated Guide for the Rest of Us.

Do you ever second-guess yourself for not investing in a certain stock? It’s time to find out what you could’ve made. Find out→

DRIP Method How to Grow Dividend Portfolio

Now $1.7 million dollars is a lot of money and may seem unattainable in your lifetime. However with the DRIP method you can use the power of compounding to your advantage.

2 things must happen for this to work. 1) You must consistently invest a set amount of money EACH month into your dividends for years and years to come.2) You must reinvest all the dividend payments you receive from owning these stocks.

By doing these two things you can make amazing things happen.

If you had initial investment of $5,000 and then continued to contribute $1,500 every single month for 25 years with the dividend return of 4% and an average growth rate of the stock and the average growth rate for the dividend.

In 25 years you would be worth $1.4 million. And at that point, Based off our calculations from earlier in the video, you would have an average annual income of $57,000, all completely passive dividend payments, and you could finally become financially free.

Living Off Dividends Calculator

To simplify things for you, check out this dividend reinvestment calculator. This free tool reveals how your portfolio value grows when dividends are reinvested.

You want to get the most realistic growth prediction. I recommend choosing a stock and researching the needed information.

That way you’re using real numbers from a real stock that you own or want to own. It will produce real growth numbers for you. Not ones that are fabricated.

Dividend Investing for passive income

As with many things in life, there is certainly more than one way to generate passive income in retirement.

Examples include bonds that pay fixed amounts to holders, preferred stocks, which is perpetual equity that behaves like a bond, real estate investments, and of course, dividend stocks. We favor the latter because of the various options for passive income, it is the most likely to provide a strong mix of capital appreciation, growing amounts of income over time, and high yields.

In addition, investing in dividend stocks provides exceptional liquidity compared to the other options for passive income, so it truly is a great choice for generating income from a portfolio.

Jonathan Bednar, a Certified Financial Planner at WhatTheWealth.com shares his enthusiasm of passive income from dividends.   He offers,

“What if you could passively increase your passive income? One of my favorite ways to focus on dividend investing is to dig a little deeper and look for those companies that concentrate on dividend growth. These companies not only pay but raise their dividends year after year. Dividend growth is a great way to passively increase your income and also combat inflation, which at currently around 8.5% is on everyone’s mind.”

The goal is to generate enough income that one can live off the proceeds, at least in part. The options are numerous within the realm of dividend stocks, including finding those with the best dividend growth prospects, those with the safest payouts, the longest dividend increase streaks, or the highest current dividend yields.

Each of those strategies has their own merit, and depending upon each individual’s goals, the size of the portfolio, and risk tolerance, one of these strategies, or a combination, may best suit. Now, we’ll take a look at some examples of high-quality dividend stocks we think are great additions to passive income portfolios.

Dividend ETFs

It can be hard to find the right stocks for dividends. Furthermore, achieving sufficient diversification is even more challenging for small investors.

Fortunately, some ETFs deploy dividend strategies for you. Dividend growth ETFs focus on stocks that are likely to grow their dividends in the future. If you are looking for current income, high-dividend-yield ETFs are a better choice.

Risk of Living Off High Dividend Yields

Watch out for a high dividend yield. Many times, when a company is producing a high dividend yield, it’s to entice stockholders to buy. Although, high payouts aren’t always sustainable.

Avoid the dividend stocks that are bearish in the long term. Make sure there isn’t anything fishy going on with the company in the background.

Those two pieces of advice should help you continue living off dividends and keep you out of trouble. Because the last thing you want is to invest in a failing company and lose your money. Even the shrinking of your money is a bad deal. It defeats the purpose of investing at all.

A growing stock keeps things moving up, so your money can keep rising as you stop contributing to it.

Here’s something else to keep in mind…

A bummer when it comes to taxes on dividends is that you pay taxes twice, sometimes three times. And this is common across the board when it comes to taxes.

Here’s what I mean. You earn money from your job and pay taxes on that income. Then you invest what’s left into a dividend stock. You receive dividends. If you earn more than $40K in dividend income, you pay another tax. Plus, if you ever want to take your money out of a stock that’s climbed higher, you might have to pay even. more capital gains taxes.

How long will it take to accumulate the required sum?

How can you live comfortably off stock dividends? To reach an income of $100 per month, you need to invest $40,000. You can accumulate this amount in about 7 years. To reach this amount, you need to save about $400 every month ($5,000 per year) and have a return on investment of at least 5% per year. You must invest all the resulting profits in the purchase of new shares. In the first year, you will set aside $5,000 and get an income of $250 from interest. In the second year, you will have saved up $10,250 ($5250 from last year plus $5,000 this year) and you will receive a yearly interest income of $763. In 7 years, you will have accumulated $40,710.

Notice the difference. If you save $100 per month, you will need as much as 21 years to get to $40,000.

Please beware that these are very approximate calculations. Many factors might influence the growth of dividend income, such as the size of the company’s profit, the increase or decrease in payments on shares, macroeconomic indicators and the state of the economy as a whole.

How can you account for inflation and use an individual investment account to increase savings?

The undoubted advantage of dividend stocks is the automatic accounting of inflation. The interest on the shares is paid out of the company’s profits. Therefore, the change in the level of inflation does not affect them as much as bank deposits or other transactions.

For instance, a company accounts for inflation when raising the final cost of its products as a response to an increase in production costs. Its cash flows grow, it preserves its profit and pays dividends, protecting investors from inflation.

How Much Invested To Live Off Dividends

Since we have only looked at the average U.S. household. Seeking the best dividend stocks with an average dividend yield.

But not everyone, especially you and me, strive to be average! When it comes to our dividend investing.

Example 1: How Much Money To Live Off Dividends For Alex

The situation…

Alex is in her 20s and she wants financial freedom at a young age.

She lives on just $20,000 per year. Sharing an apartment with a friend. And being conservative with her spending.

Furthermore, Alex doesn’t mind taking a little extra risk with her investments. And believes she can build a sustainable beginners dividend portfolio that has a dividend yield of 5%.

Finally, she thinks she can get a higher dividend yield. By concentrating her portfolio on real estate investment trust stocks.

How much investment is required for Alex to live off dividends?

$20,000 / .05 = $400,000

Example 2: How Much Money To Live Off Dividends For Jack & Diane

The situation…

Jack and Diane are in their 30s. And they want to start living off dividends as soon as their daughter graduates from college.

By then, they will be in their mid-40s. And want to travel a lot. While they are still young and fit enough to do so.

They have analyzed their expenses. And have increased them to cover travel costs. Also, premiums for health insurance.

Thus, they feel they need $120,000 in annual income from dividends. Or, $10,000 per month.

Furthermore, Diane is the investor in the family. And she’s determined to get rich off stocks that pay dividends.

While managing her dividend portfolio to yield 4% on average.

How much investment is required for Jack and Diane to live off dividends?

$120,000 / .04 = $3,000,000

Example 3: How Much To Invest To Live Off Dividends For Tim & Mindy

The situation…

Tim and Mindy want to retire in their mid-60s. And they have done a great job planning for it.

First, their home is paid for. Second, Medicare will cover the bulk of their health care costs. Finally, their wants and needs are few.

They want days to just take it easy. Work in their garden. And play with the grandkids.

And as a bonus, they will be receiving monthly social security payments.

So, Tim estimated their annual expenses. Then he subtracted the amount they will receive in social security income. It came to $40,000.

Tim also handles the family investments. He wants to invest a bit more for growth. And a little less for dividend income.

Furthermore, Tim likes to hold a blend of individual dividend stocks. Along with some mutual funds he has selected himself. To provide for greater diversification.

Thus, a 3% dividend portfolio yield feels about right to him. And he hopes a million dollars in dividend-paying investments will get the job done.

So, let’s see if he’s in the ballpark…

How much investment to live off dividends is required for Tim and Mindy?

$40,000 / .03 = $1,333,333

Okay. With those examples under your belt. You should be able to answer the question: how much investment money is required to live off dividends.

Next, let’s cover several important and related topics…

Your Partner On The Investing Journey

At Bay Point Wealth, we believe dividends should account for just one portion of your investment portfolio. This approach will help you minimize risk while still achieving returns and enjoying a stress-free retirement. Creating a diversified rather than a concentrated portfolio is the best way to increase your returns. If you’d like to learn more about our investment philosophy and how it could work for you, schedule a call with us today.

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