A plan to retire at age 55 and live off dividend income from stocks will allow an early retiree to refrain from exploiting the principal in their investment portfolio, while also avoiding the need to earn income by earning an income. However, given the currently low yields of dividend-paying stocks, it is particularly challenging to accumulate enough capital to generate strictly dividend income. Therefore, a successful strategy leading to retirement at age 55 is likely to require radical cuts in living expenses.
To help plan a strategy for retiring at age 55 and living off dividends, consider working with a financial advisor.
Dividend Financing Retirement
Traditionally, people planning for retirement rely heavily on Social Security and interest on fixed income securities such as bonds. However, 55 is seven years before the earliest age most people can withdraw Social Security. And with interest rates just above recent all-time lows, bonds aren’t offering much help right now. Thirty-year Treasury bonds, for example, are paying just over 2%, while inflation is three times higher.
Stocks offer a chance to earn higher total returns. But with the market’s sharp decline from the last great recession still relatively fresh in memory, many retirement savers also feel uneasy about paying for retirement by taking the principal out of the investment. Especially in the early years of retirement, being forced to sell stocks during a recession can wreak havoc on the long-term viability of a retirement plan.
Dividend-paying stocks may represent a potentially better third option. Investors who do not sell their shares, but simply collect the dividends, can better resist price drops. Compared to fixed income investments, dividend yields are generally higher. And the idea of living off dividends while leaving the nest egg untouched has undeniable appeal. Here’s how to use dividends to fund an early retirement at age 55.
Investment for dividends
One approach to investing in dividends involves buying shares in a group of companies called Dividend Aristocrats. These are large companies with a long history of paying ever-increasing dividends. While past performance does not necessarily indicate future performance, the idea is that these companies will continue to pay dividends that grow as fast or faster than inflation.
Dividend aristocrats typically yielded more than 3%, making them significantly more attractive than many fixed-income instruments. At the moment, however, thanks to strong price appreciation in the stock market, an exchange-traded fund that tracks the S&P 500 Dividend Aristocrats index, for example, is earning less than 2% of dividends.
Some dividend games have much higher yields. However, companies with high dividend yields are not always good investments. Yields are sometimes high because the company is in financial trouble and may need to cut the dividend.
At a yield of 2%, a $1 million investment yields $20,000 a year. That’s not much more than the federal poverty level for a couple. To earn dividends equivalent to something like four times the poverty level of $17,420 for two people, a retiring couple would need approximately $3.5 million worth of stock at 2%.
For most people, this will take a lot of discipline and self-sacrifice to save and invest from an early age. The SmartAsset Retirement Calculator can help you determine how much you will need to save, depending on factors such as your age and location, to have that amount at 55.
Estimate of Income Needs
With these dividend yields in mind, a viable plan to retire at age 55 will likely emphasize reducing the need for retirement income. Most estimate post-retirement income needs at about 70% of pre-retirement income. This can vary greatly depending on income level, health, life expectancy and other factors.
Importantly, these estimates of post-retirement income requirements are intended to give retirees the same lifestyle they had while working. A retirement planner who expects to live on dividends may, by being willing to accept a significantly cheaper lifestyle, have a better chance of the plan working.
You can limit your post-retirement expenses for a dividend-based retirement plan to work. To do this, multiply the amount you expect to have in your retirement plan by 2%, which is your current Dividend Aristocrats income.
Ways to cut retirement costs
Real estate is the single biggest cost for most families, and this is where many retirees look for savings. Retirees can significantly reduce the cost of housing by downsizing and moving to a cheaper location. Another way to reduce the cost in retirement is to pay off debts like mortgages and car loans while you’re still working.
Health is another place to look. As people age, they generally spend more on health. A widely cited study by Fidelity said that a 65-year-old couple can expect to spend $300,000 after-tax on healthcare costs in retirement. And that’s while covered by Medicare. A 55-year-old retiree must find a way to pay for a decade’s worth of health care before the government health plan starts covering it. So staying healthy as much as possible is potentially another way to reduce retirement expenses.
Funding retirement from age 55 with dividends allows retirees to avoid using the principal in their investment portfolios to pay expenses. Dividends are typically higher than fixed income, and owning stocks that pay dividends can help investors weather crises when stock prices drop. However, dividend yields are currently low, so planning to pay retirement strictly with dividends will likely require significant compromises in post-retirement standard of living.
To ensure you have enough income when you retire, consider consulting a financial advisor. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your field, and you can interview your advisor peers at no cost to decide which one is right for you. If you’re ready to find a consultant who can help you achieve your financial goals, start now.
Even if you’re investing in dividend stocks, be sure to use a workplace retirement plan like a 401(k), if you have access to one.
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