What Dividends Can (And Can’t) Do for Your Retirement Carmichael Hill

One investment strategy that can be useful when it comes to setting yourself up for retirement is dividends. Dividends are regular payouts to shareholders based on the profits of the company. They are discretionary, which means that the company isn’t required to pay it. Dividends can be reduced or stopped entirely if the company falls on hard times. But if you own some stock in a company, it’s possible that you will get regular dividends.[1]

Dividends are traditionally distributed quarterly, and they scale with how much stock you have in a company. So, for example, if a company paid out $1 per share to their investors as a dividend and you owned 5 shares, you would receive $5 as a dividend.[2]

Advantages of Dividends

Dividends can be a good way to create a steady income and hedge against poor price performance from investments in your portfolio.[3] If the companies you invest in offer dividends and the market starts to turn down, you can frequently still count on dividends to provide income. Companies that pay regular dividends typically loathe having to cut them. It’s generally perceived as a red flag and indicative of financial trouble, which oftentimes drives the stock price even lower.

Dividend stocks can also be useful to offset more volatile equity stocks.[4] If you have stocks that represent a risk and may fluctuate in value significantly, dividends can help to mitigate some of that risk by providing consistent payouts in quarters where the company share price declined.

Disadvantages of Dividends

Not all companies offer dividend payments. Dividends tend to be offered by mature companies with proven business models, reliable customer bases, and stable cash flows. If you are thinking about using dividends to set up a retirement income stream, then you need to make sure that the companies in which you are investing actually pay dividends.

It is also possible that a company will decide not to pay out dividends, even though it has done so in the past. Disney is a good recent example of this. So while a company that has historically paid dividends may continue to do so, there is always a risk that they suspend, reduce, or cancel their regular dividend payments.[5]

Last but not least are the tax issues. Dividends come in two flavors: ordinary and qualified. Qualified dividends are taxed at the same rate as long-term capital gains. This caps the tax at a maximum of 20%. Ordinary dividends are taxed at ordinary income tax rates, which means it’s treated just like income from a job. The maximum rate on ordinary dividends is, therefore, 37%.

Lastly, dividends are often taxed at a much higher rate than capital gains.[6] Generally, when you sell a share of a company, any money you make from that sale is taxed as a “capital gain.” Dividends are taxed as income as if you made the money from a job, and that rate is much higher than the rate for capital gains.

The Takeaway

If you’re not sure if you should add dividends to your financial plan, contact us today for a complimentary review of your retirement strategies.

 

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