Why Not Use Dividend Stocks For Retirement Income?

Why Not Use Dividend Stocks for Retirement Income?

Today we answer a viewer question about using dividend stocks to create retirement income.

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Our question from Ronald. He writes:

I am looking to retire soon and trying to determine the best way to generate retirement income with interest rates so low. Traditionally, you could have done this with treasuries or CDs. Why wouldn’t buying dividend stocks paying 4% to 5% makes sense? In addition to the dividends, you have the opportunity for appreciation.

The Challenge of Low Interest Rates

Ron makes a couple of good points. Interest rates are ridiculously low right now. Traditional methods of using bonds or CD’s to generate income are a challenge. Ten-year Treasuries are yielding about 1%. Thirty-year Treasuries yield about 1.8%. CDs, unless you lock those up for a few years, are going to be well below 1%. Using these interest-bearing investments to create retirement income is very difficult.

Using Dividend Stocks For Retirement Income

Why can’t you use a portfolio of dividend-paying stocks to create that income? You can, and there are some benefits. The dividend income is more than you would earn on a lot of fixed-income investments. You also have the opportunity for capital appreciation. Many of these companies will increase their dividends over time. And there are some tax advantages.

The Challenges

1. Volatility

But there are significant challenges to doing this. The first one is volatility. Companies who pay good dividends will decrease in value. You are going to see periods where your account drops 20%-30%. You must be able to withstand those periods, and not sell something at an inopportune time.

2. Portfolio Construction

The next challenge you have is how you build your portfolio. You want to make sure you have diversification across different industries. You want to make sure you are picking good companies.

Oil companies provide a great example of why you should diversify. When oil prices went down last year, many oil companies saw their share prices decrease. Many of them also decreased their dividend. Investing too much in one industry could impact your ability to maintain your income.

Stock selection is also important. Look for companies that have good earnings as well as a decent payout ratio. (The payout ratio is how much of the earnings are being paid out as dividends.) If a company is paying more in dividends than they earn, it could be a problem down the road.

You also want to look at their dividend history. Has the company been able to maintain their dividend over time? Have they been able to increase their dividend over time? Or have they had periods where they cut the dividend? When you depend on that income, the last thing you want to see is your income cut.

You want to be cautious of owning too few companies. When you own too many shares of one company, bad news could hurt your account.

3. What if You Need Extra Income?

You may find you need extra income. This can also be a challenge. You can sell positions that have appreciated in value. But when you sell those shares, your future dividend income is going to decrease. It can create a problem if you do need extra income. One of the ways to address that challenge is to have a bigger emergency fund on hand. When you need extra income, use your emergency fund and not disrupt your regular income flow.

Tax Advantages for Using Dividend Stocks to Create Retirement Income

This can be a tax-advantaged way to generate income in a non-IRA account. Qualified dividends receive preferential tax treatment. For most people, qualified dividends get taxed at 15%. It could be lower, depending on your total income. Other types of income are taxed at higher rates.

Qualified dividends come from common stocks of US companies and some international companies. When you build a portfolio of common stocks, you are going to be in a more tax-advantaged position.

Some higher-yielding investments pay dividends that are not qualified. Real Estate Investment Trusts (REIT’s), Master Limited Partnerships, and Business Development Companies pay good dividends. But those payments are not qualified. You can hold those, but you will not see the same tax benefits.

If you can handle all the challenges, using dividend stocks to create retirement income can be a good strategy. But it may not be easy.

Talk to a Certified Financial Planner™ Professional

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Investing vs. Speculating

Investing vs. Speculating

Today we are going to talk about the difference between investing and speculating.  

We have all heard about GameStop and some of the other companies. There were meteoric rises, significant drops, and prices went right back up. There is a lot of speculating and manipulation going on with this company. At the end of the week, it caused some extra volatility in the stock market.

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speculating investing

We want to cover a couple of different things today. First, let’s talk about the difference between investing and speculating.

Investing vs. Speculating

Investing is a long-term process that we use to build wealth over time.

Speculating is a short term bet to pursue a big payoff.

Investing —if you avoid key mistakes, and ride through some of the setbacks—has a high probability of success over long periods of time.

Speculating has a high probability of failure. But a big return potential.

Investing is a boring, uneventful process—most of the time. There are periods of absolute terror, like last spring.

Speculating is an adrenaline-pumping game. It is exciting and exhilarating.

Most of us want to be investors and pursue the long-term accumulation of wealth. It is fine to speculate from time to time. But understand you could lose everything you bet very quickly.

If you make big bets trying to time your entry points in and out of something like GameStop, you have a low chance of doing it well. You may have some temporary success, but at some point, things are going to go against you. Things can get very ugly before you have a chance to react.

If you want to be a speculator, go for it. Keep your bets small and only bet what you can afford to lose.

Anxiety in the Stock Market

These events are causing some temporary anxiety for the stock market. But there are big differences in what’s going on with these few companies and what most people try to do. The trading activity in companies like GameStop does not decrease the value of the other great businesses.

We’ve seen many temporary setbacks over the past 100 years. This may be another one.  For investors who own shares of good companies, stick with it, and don’t panic, things tend to work in their favor.

Talk to a Certified Financial Planner™ Professional

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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A Stock Market Crash is Always Coming

A Stock Market Crash is Always Coming

A stock market crash is always coming.  

A good friend of mine sent me an article last week written by the folks at motleyfool.com. Four Reasons the Market will Crash in the Next Three Months.

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The reasons they gave were:

  • Increased restrictions due to the virus
  • The vaccine euphoria would evaporate. (Remember in the last quarter of 2020, the stock market got a big boost on the vaccine news.)
  • Democrats would win the two Senate races in the Georgia runoffs. (This already happened.)
  • And history repeating itself.

Here’s the truth about the stock market.  The stock market goes up, it goes down, and then it goes back up, again. There is always a crash of some magnitude coming.

Crashes are Normal

Your definition of a crash and my definition of a crash are probably two different things. To me, a crash is a significant drop. What we saw last spring, that was a crash. Others include:

  • The “dot com” bust
  • the Great Recession
  • 1987
  • And the end of 2018, when the market dropped almost 20% over the course of three months.

You can look at the data going back into the 1920s and see that market crashes happen all the time.

Annual Corrections

The average calendar year correction since 1980 is -14%. The smallest was -3%. And the small corrections are rarer than the bigger ones.

The largest was -47%. That happened back in 2008. Last year, the correction was -35%. It was the second-worst drop in the last 41 years.

These events happen regularly. What is more important is what happens after the crashes. The stock market’s total return in 2020. was +18.4% last year. It erased the losses and produced a gain of almost 20%!

A stock market crash is always coming

Over the last 41 years,

  • There has been a drop of -10% or more at least 23 times
  • the market has gone down by more than -14% 16 times
  • and the compounded average annual return over the 41-year timeframe is +11.9% per year.

Stop and think about what has happened over the last four decades.

Despite all that happened, the stock market rewarded investors with an 11.9% average annual return.

Don’t worry about the headlines. You can write these stories every month from here to eternity. The crashes are going to happen. History shows us time and time again, those who weather the storms are rewarded.

Talk to a Certified Financial Planner™ Professional

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Taxing Social Security

Taxing Social Security

Today we talk about taxing Social Security. We will discuss:

  • the factors that go into determining whether your Social Security income is taxable or not
  • give you some examples, and
  • tell you about a few potential surprises that you may encounter.

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Taxing Other Types Of Retirement Income

Last week we discussed how other types of common retirement income are taxed. Click Here to watch that episode.

Today, we focus on taxing Social Security benefits. For some people, your Social Security may be taxable. Here is how we can determine if your benefits will be taxed.

Provisional Income

It starts with your provisional income. To determine if your Social Security is taxable, you’ll need to compute this. It includes:

  • half of your Social Security
  • dividends
  • interest, both taxable and non taxable
  • earnings
  • pension income
  • IRA distributions, and
  • other income

If your provisional income is less than

  • $32,000, for a couple
  • $25,000 for a single person,

your Social Security benefits are not taxed.

But if your provisional income is between

  • $32,000- $44,000 for a couple
  • $25,000- $34,000, for a single filer,

50% of your Social Security income is taxed.

And if your provisional income is over

  • $44,000 for a couple
  • $32,000 for a single person

85% of your Social Security benefits is taxed.

Examples

John and Carol

John receives about $27,600 in Social Security benefits and Carol receives $21,600. That totals $49,200. Half of their benefit is $24,600. They receive $2,000 a month from John’s IRA, for a total of $24,000. Total, they earn $5,000 per year in dividends and another $1,500 in interest.

Their provisional income is $55,100. This means 85% of their Social Security benefits are taxable.

taxing Social Security

Mary

Mary was recently widowed. She receives $21,600 in Social Security, half of which is $10,800. She takes a required minimum distribution from her IRA which was $8,300. Her provisional income in this case is $19,100. This is below the $25,000 threshold, so her Social Security benefits are not taxed.

taxing Social Security

Carl

Carl is single. He receives $2,000 per month from Social Security, $24,000 total. Half of that is $12,000. He also gets about $2,000 in dividends and $1,000 in interest. The rest of Karl’s income comes from a Roth IRA. He takes $50,000 from his Roth account. His provisional income is $15,000.  His Social Security benefits will not be taxed.

The Roth IRA distributions do not add to his provisional income.This is an additional benefit of using a Roth IRA in your retirement planning. Distributions from the Roth are not taxed. They also won’t make your Social Security benefits taxable.

taxing Social Security

Potential Surprises

Change in Marital Status

The first surprise is a sudden change in your marital status. If you find yourself suddenly single, you may owe more in taxes. The income limits for single people are lower than those for married couples. A sudden change in marital status may lead to more of your social security benefits being taxed.

Change in Income

A sudden increase in your income can also have a hidden surprise. This normally happens when you reach the age for required minimum distributions. At age 72, you have to start taking money from your IRA account. This will add to your provisional income. The distribution may cause your Social Security income to be taxed

Talk to a Certified Financial Planner™ Professional

There are a lot of factors that affect your taxes in your retirement, and you can manage some of them. Talk to a financial planner to learn more.

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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How Retirement Income is Taxed

How Retirement Income is Taxed

How Retirement Income is Taxed

Today we look at how the most common types of retirement income are taxed.  We look at:

  • The common types of accounts retirees use
  • The types of income taxed at the highest rates
  • Types of income which receive favorable tax treatment

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When you retire, you go from earning a paycheck to using your savings to create a paycheck. You will still have to pay income taxes. Today, we look at the common types of accounts retirees use to create income, and how they are taxed.

Retirement Plans and IRA's

This might be a 401k, a 403b or even a 457 deferred compensation plan. Many people roll those over into an IRA.

The taxation of the income generated from those accounts depends on the contributions. If you made pre-tax contributions—meaning you took a tax deduction—the income is taxable. Your contributions, your employer’s contributions, and the earnings are taxed as ordinary income. Tax rates for ordinary income start at 10%. The maximum tax rate is 37%.

If you used the Roth type accounts, the contributions happened on an after tax basis. This means withdrawals from these accounts are not taxed.

Individual and Joint Accounts

The second type of account that retirees use is an individual or a joint account. If you have this type of account, you pay taxes “as you go”. The investments in those accounts often pay dividends or interest. Interest is usually taxed as ordinary income. Dividends paid by a common stock get favorable tax treatment. In most cases, the highest tax rate for qualified dividends is 15%.

You may also have capital gains. A capital gain happens when you or one of the investments you own sells an investment. If you own a mutual fund, that mutual fund may buy and sell stocks and bonds inside the mutual fund. The gains pass to you as a shareholder.

If you own an individual investment, and you sell those shares, you can generate a capital gain as well. If you owned the position for at least a year, the gain is a long-term capital gain. Long-term gains get favorable tax treatment. The highest capital gains rate is 20%. Most people will pay 15%. The full amount of the sale is not usually taxed. Taxes are due on the amount above what you originally paid for the investment.

This can be a factor if you are using a systematic withdrawal. This strategy involves selling shares of your investments to generate monthly income. Part of the income is going to be taxable, and part of it is going to be return of your principal. The taxable part may get taxed at lower rates.

Pension Plans

The other type of account used to create income in retirement is a pension plan. If your company offered a pension plan, the income is taxable as ordinary income.

Annuities

Another common type of account is an annuity. If you annuitize a contract, part of the income is taxable. The balance is a return of your principal.

Social Security

The last type of income source that’s taxable in retirement is Social Security. We will cover taxes of Social Security benefits next week.

Talk to a Certified Financial Planner™ Professional

Knowing how taxes impact retirement can help you plan for a better future. If you have questions or concerns, talk to a financial planner.

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

Our Most Recent Videos And Posts