One area that causes anxiety for many people as they approach retirement is whether or not they will have enough money to last them for the rest of their lives. Many Americans worry about running out of money during retirement, and this anxiety can cause them to shy away from risky investments such as stocks once they retire. At the same time, low-yield bonds may not provide sufficient investment growth for their portfolio, so individuals need to strike a balance between risk and return. Some people may look to nuanced investment options to achieve this balance, such as fixed-indexed annuities or dividend-paying stocks. While the right option will depend on each person’s financial situation, dividend-paying stocks can provide several benefits for retirees:
1. Tax breaks
Retirees often fail to plan adequately for their taxes, which can become quite challenging during retirement and cut into their expected income. Luckily, the IRS puts most dividends under the heading of “qualified dividends,” meaning that they receive special tax treatment. Qualified dividends are taxed at a much lower rate than the general income rate applied to tax-advantaged account withdrawals. People who claim at least $40,125 in retirement will be taxed at a rate of 22 percent or higher depending on the total, but the tax rate on qualified dividends is only 15 percent. Thus, using dividend-paying stocks can help to reduce the overall tax rate since the dividends are not included in taxed income. With dividends, individuals can withdraw less from their tax-advantaged accounts and may even keep themselves in a lower tax bracket.
2. Protection from market volatility
Market volatility can cause a lot of problems for people in retirement. Individuals have likely spent decades building up their savings in a 401(k) or IRA, and a sudden drop in the market before or during retirement can significantly reduce the value of these accounts. Moreover, withdrawing from these accounts during this period can limit their ability to recover from a drop in the market. Withdrawing funds when the market is down can actually lock in losses. Dividend-paying stocks provide a source of revenue that can help individuals to minimize the amount of money they need to withdraw during market downturns. Importantly, dividends are not guaranteed. However, companies with a strong record of paying them tend to do so even when the market is down, so this income can provide important financial protection.
3. Provide profits in two primary ways
One of the primary advantages of investing in dividend-paying stocks is the fact that they provide profit in two distinct ways. These investments offer dividend cash payments while also growing in value over time. With both income and growth, the investments tend to produce returns in virtually any market environment. The value of these stocks will increase over time when the market is up, and the dividends should keep coming when the market is down. As we’ve already mentioned, dividend payers can reduce their payments, although this is a rare occurrence among established companies. Still, investors need to account for this possibility in order to keep their portfolios afloat.
4. Greater stability
Any organization that offers dividend-producing stocks is making a massive cash commitment to its investors. Leaders of the organization accept this commitment as a means of making their stock more attractive, and the strategy definitely pays off for them. However, not every public company can pull off dividends, and an organization’s ability to do so speaks to the predictability of cash flow and the discipline of its leadership team. These factors indicate stability, which means that the investments have a relatively lower risk. Balancing risk is important for retirees, so these stocks are often a good bet for individuals who are unwilling to gamble in retirement. While the stocks generally do not experience explosive growth, they will also not fall hard when the market turns.
5. Hedge against inflation
Retirees must pay close attention to inflation. While Social Security comes with a regular cost-of-living adjustment, the same does not occur with retirement accounts. Some accounts with low risk will not even grow at the same rate as inflation, which means that the value of the portfolio actually decreases over time. Dividend-paying stocks are a great way for retirees to hedge against inflation. The only way to hedge against inflation is to increase your income, which is what dividend-producing stocks can do. Individuals may want to pay close attention to the Dividend Aristocrats, a list of dividend payers that have consistently increased payments over the course of at least 25 years. The dividends from these organizations are unlikely to be unmet and, moreover, will likely increase over time along with inflation.
6. Higher returns
Dividend-producing stocks often have higher payments than similar types of investments. Currently, the average dividend yield of the S&P 500 is about 1.9 percent. However, the Dividend Aristocrats mentioned above have an average yield of 2.4 percent. While these dividend returns are still not as high as riskier stock options, they are much better than some of the low-risk investments traditionally associated with retirement. For example, the return on a 10-year Treasury bond is only about 0.6 percent. While these investments do have greater risk than a Treasury bond, the return is much more impressive without posing a high risk to retirees. Before investing in one of these stocks, people should look carefully at the history of returns, as well as market performance.