For anyone considering their financial future, a top concern often is running out of money in retirement. The fear of not being able to cover monthly expenses has delayed many retirement plans — something the right strategy can help alleviate. 

Many investors use dividend-paying stocks to avoid outliving their savings and live off passive income in retirement. However, generating an income stream to cover your entire cost of living in retirement isn’t easy.

This article explains what dividend stocks are, walks you through the practical reality of dividend investing, and explores other ways to accumulate and maintain retirement income.

{{key-takeaways}}

Dividend stocks for retirement

A dividend is a payment a company makes — from its profits — to shareholders. Most companies make quarterly dividend payments. Some various real estate investment trusts (REITs), pay dividends monthly.

Shareholders can choose to reinvest dividend payments into new shares of the company’s stock. This strategy, known as dividend growth investing, leverages the power of compound returns to help amplify your savings potential. 

Dividend growth stocks are known for typically increasing their dividend payout each consecutive year. Many blue chip stocks have increased their dividend payout annually for at least 25 years in a row. These are known as dividend aristocrats.

Investing in well-established companies with strong financials and healthy dividends can help address the cash flow needs of retirees.

Are dividends guaranteed?

Dividends aren’t guaranteed. The continuity of dividends depends on the type of dividend paying stock invested in: common stock versus preferred stock.

Common stock dividends are not fixed; they’re variable. A company’s board of directors, typically acting on direction from management, decides whether to increase, decrease, or cancel dividend.

When a company faces financial difficulties, often due to economic shocks or restructures, the dividend is often cut. Here are a few real-world examples that illustrate this risk:

• During the financial crisis of 2008-2009, Wells Fargo cut its dividend by 85% to preserve capital.
• In 2020, at the beginning of the COVID-19 pandemic, The Walt Disney Company halted payment of its dividend, resulting in cash savings of about $1.6 billion. 
• In 2022, AT&T, a perennial dividend aristocrat loved by retirees, slashed its dividend by half due to restructuring. 

These cases show that reliance on one dividend paying stock is precarious. While dividend cuts among blue chips can be rare, the next economic crisis or organizational failure could easily change that. 

Hence, diversification remains paramount. A diversified portfolio that includes multiple potential income streams is seen as a safer choice, offering more resilience against company-specific setbacks.

Preferred stocks can provide more stability. They function more like a bond — paying a fixed dividend with less volatility. But they come with trade-offs: They hold greater income certainty but have less potential for capital appreciation and typically no voting rights in company decisions. 

Despite more stability of preferred stocks, most retirees use common stock dividends to build their income stream via dividend growth.

‍

{{inline-cta}}

How to retire on dividends: Step by step

Run the math when planning to retire on dividend-paying stocks. The core rule is:

Required portfolio = Desired annual dividend income / Expected sustainable dividend yield

This formula gives you an estimate of how much you need to invest to reach your target annual income.

Here’s a step-by-step guide of a hypothetical example to help you plan for your desired dividend income.

1. Set a realistic income target

If your retirement expenses are $6,000 a month and you’ll receive $2,000 from Social Security and $2,000 in guaranteed monthly annuity payments, you’ll need another $2,000 from your dividend stocks. That’s $24,000 a year in dividend income. 

2. Choose yield target 

Dividend yield is a percentage that shows how much a company pays in dividend relative to its stock price. You can calculate dividend yield using this formula: 

Dividend yield = (Annual dividend / Stock price) x 100 

So, a company with an annual dividend of $1.00 per share and a stock price of $50 has a dividend yield of 2.0%. 

Dividend yields typically range between 3% and 5%. Be cautious of dividend stocks with extremely high yields, typically 6% or higher — yield traps. 

Assuming no change to the dividend, dividend yield goes up when the price of a stock drops. So, a high or rising yield may be due to declining stock prices, indicating financial trouble at a company and a potentially unstable dividend. Your retirement planning should focus on the expected dividend yield of your entire dividend portfolio.

3. Estimate your portfolio size 

This step helps you determine whether it’s realistic to live on dividend income. Use the core formula from above to calculate the total investment required to get to your target annual dividend:

Required portfolio = Desired annual dividend income / Expected sustainable dividend yield

To produce $24,000 a year, you would need to yield 3% on an $800,000 portfolio. At a 5% yield, you’ll need a $480,000 portfolio. If you want a higher annual dividend income of $50,000, you would need a $1,666,667 portfolio at a 3% yield and a $1,000,000 portfolio at a 5% yield.

These are big numbers that drive home the reality — living off of a dividend portfolio in retirement isn’t easy.

4. Build core plus satellite allocation

Many investors use a core-satellite approach to balance stability and growth: 

• Core (70-80%): This portion is invested in blue chip stocks, such as dividend aristocrats and low-cost dividend growth exchange-traded funds (ETFs), for constant returns.
• Satellite (20-30%): Invest in higher yield REITs or high-yield dividend stocks to boost dividend yield.

5. Ladder cash for 1–3 years of spending

For this strategy you can invest and allocate to highly liquid assets, such as a high-yield savings account or short-term bonds, with maturity dates scattered. This ensures you get some cash at regular intervals to cover your expected expenses during the next 1–3 years.

6. Tax-efficient account placement

To maximize your retirement income from dividends, it is ideal to monitor your tax exposure and adjust portfolio allocation accordingly.

From a tax perspective, dividends fall into two main categories:

• Qualified dividends: Most U.S. common stocks provide qualified dividends. The Internal Revenue Service (IRS) taxes these dividends typically at lower rates: 0%, 15%, or 20%, depending on income.
• Ordinary dividends: These dividends are generally paid by REITs and are subject to ordinary income tax rates, which can be as high as 37%.
  

Pro tip: For assets that generate highly-taxed ordinary income (like from REITs), consider using tax-advantaged accounts, such as an Individual Retirement Account (IRA). You could then keep other dividend stocks in a taxable brokerage account for easier access and cash flow management.

7. Monitor and rebalance annually

It is important to focus on your portfolio’s total return — that is, income from dividends plus stock price or capital appreciation — not just dividend yield. Annually review your dividend portfolio and rebalance to align with your targets. Look to sell stocks that underperform or become overallocated, and consider purchasing others that optimize risk and return.

Reliable income in retirement with Gainbridge

Living off dividend income sounds like a great retirement plan, but it can also require a hands-on approach and significant investment dollars. Relying exclusively on dividend stocks means keeping your money locked up in the stock market, subject to volatility and individual company dividend cuts.

For most retirees, diversification can be the most sustainable investment plan to balance growth and income in retirement. To achieve this balance and peace of mind, it’s best to strive for multiple guaranteed income streams. This can be a combination of Social Security, pensions, and annuities.

Gainbridge can help you incorporate annuities into your retirement plan to generate income you can count on for life. Income that relies on dividend investing isn’t guaranteed. But you can rely on annuity payments — not only to help fund your retirement but also to leave something behind for your loved ones. 

Learn how to combine fixed rate growth and reliable income in retirement with Gainbridge today.

‍This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The GainbridgeⓇ digital platform provides informational and educational resources intended only for self-directed purposes. Guarantees are backed by the financial strength and claims-paying ability of the issuer.