If you have any hopes and dreams at all of retiring early, then you know that one of the biggest challenges you face is the fact that there are penalties for withdrawing your money too early from your retirement accounts. For most of them, this will be age 59 ½ (click here for a complete list). So one of the re-occurring questions that we keep asking on MyMoneyDesign is:
• How do I bridge the gap between early retirement and age 59 ½?
In previous posts, we’ve reviewed the following non-employment, investment-style options available:
• File for a 72t or “SEPP – Substantially Equal Periodic Payments” to get penalty free portions of your nest egg money out.
Although each of these options is a possibility, they’re not really outstanding because each one involves withdrawing from your retirement accounts sooner than later. As you can guess, the sooner you dip into your accounts, the higher your potential is for running out of money during retirement!
So what else can we do to try to add some low-cost income during early retirement?
Adding a New Alternative – Dividend Stocks:
About a year ago, I read a book called the “The Little Book of Big Dividends” by Charles B. Carlson which sparked an interest in dividend investing. For anyone who doesn’t know: A dividend stock is just a normal stock that happens to pay you money (a dividend) every quarter (every 3 months). How much money? It varies – but the average is usually about 3% per year. The dividend is actually just a cut of the earnings that the company is making.
Once I started getting into blogging, I began to notice that some people REALLY get excited about dividends stocks. Guys, gals, young, old, and even a Ninja!
All-in-all, they were all promoting a lot of the benefits that I believe would be very helpful in our options for early retirement.
Why I Think Dividend Income Would Help You Retire Early:
Here are some of the reasons dividend stock investing might be a useful part of your early retirement strategy:
• You don’t have to be a certain age to start collecting dividend income.
• Dividend income is truly passive – you don’t have to do anything to receive it except hold the stock!
• Dividend income gets taxed at a lower rate than normal; about 15% if you are in the 25% tax bracket.
• There is a great deal of evidence to support that dividend stocks generally do a lot better in the long run than non-dividend stocks (probably because you need earnings to pay dividends).
• Even if the stock price goes down (and it will sometimes), you still get your dividend income.
• Possible inflation protection! If you pick a really good company, they’ll likely increase their dividend payout each year.
• A stock is still a stock. There is never a guarantee that you won’t completely lose all your money.
• Companies can decrease or stop paying dividends anytime they want for any reason.
• Just because a stock pays a dividend doesn’t make it awesome. In fact, some scrupulous stocks issue a really high dividend to bait greedy investors.
How Much Money Will I Need?
Have you ever heard someone say “It takes money to make money”? This is literally true with dividend stocks.
Below is a chart that shows how much money (principal) you’d need to have in your account to deliver the desired after-tax dividend income you’re looking to receive (assuming a 3% dividend yield). To give you an idea of how long it would take to accumulate that much cash, I have also included an estimation of how much you’d need to save each year (assuming an 8% compound return) based on the number of years you’ve got until you wish to retire. (Read vertically down each column).
… Record Screech!!!
“I need to save how much money??? MMD, have you lost your mind? There is no way I can save up that much cash!”
True, the numbers don’t lie. For example, if I’ve got 20 years until I’d like to take an early retirement and I wish to receive $2,000 per month after taxes, then I’d need to save $20,567 per year for the next 20 years. I don’t know about you guys, but I really don’t have that kind of money!!! Especially not when I’m already stretching to max out my 401k and Roth IRA.
Even with a 4% dividend yield, the estimations slightly improve, but are still quite substantial:
While dividend income can be a slightly tax favored and a truly passive way to obtain some pre-retirement (or even post-retirement) cash flow, it may require substantially high levels of principal to make it work. Therefore, in my money design, dividend income won’t completely replace my income, but it will play a part as a compliment. For example: I may seek to only receive $500 or $1000 per month in post-tax income even though I really need more than this. Clearly I will need to use dividend income in combination with a few other tricks to maximize my pre 59 ½ income.
Looking at the big picture, I would not suggest that you sacrifice your contributions to your employer retirement plan or IRA for reasons we have discussed in previous posts. However, should you come into a surplus of savings, profit sharing, tax refunds, or happen to be an extremely diligent saver, than perhaps dividend stocks may be your next best alternative – especially if you plan to retire sooner than later!
Readers: What tricks will you use to retire early? Do you have a place for dividend stocks in your retirement plan – whether early or not?
Photo Credit: Microsoft Clip Art