As the State Pension age steadily rises, building a passive income to support my retirement is becoming more important by the day.
I’m looking to generate my retirement income by investing in a portfolio of UK shares, primarily FTSE 100 dividend stocks. Blue-chip shares listed on the index offer some of the highest shareholder payouts in the world, with the best yielding anything from 5-9% a year.
I’m buying high-yield shares
If I could generate passive income of £20,000 a year, on top of £10,000 or so from the State Pension, I would retire on £30,000 which is roughly the average salary today.
In practice, I would be much better off than the average worker though. By then, my kids should have left home and my mortgage will be history. I won’t have to make further pension contributions or pay for life insurance at that age either.
Better still, my passive £20,000 income will be free of all income tax, provided I invest inside my annual Stocks and Shares ISA allowance.
In retirement, I plan to follow something called the 4% rule. This states that if you draw 4% of your investment portfolio as income each year, your pot will never run dry. In order to generate £20,000 a year, I would therefore need a portfolio of £500,000.
This takes time to build up, of course. An entire working lifetime, to be precise. If I invested £250 a month, and increased this by 3% a year to keep pace with inflation, it will take 30 years to hit my target. Assuming an average total return of 7% a year from my portfolio, I would have built £416,096 in that time.
If I started by investing £500 a month, I could do it in just 22 years, at which point I would have £403,545. But the closer my retirement is, the more money I will need to invest each month to hit my target. And vice versa.
Some FTSE 100 favourites
I think now is a great time to buy top FTSE 100 dividend stocks, as plenty offer high yields at affordable valuations.
Packaging group Mondi, for example, yields 4.76 year, but trades at just 11.6 times earnings (a figure of 15 is seen as fair value). Insurer Aviva yields more than at 6.41% and is even cheaper at today’s valuation of 10.5 times earnings.
Housebuilder Barratt Developments yields a stunning 7.81% and is trading at a rock-bottom 5.7 times earnings. At 10.71%, miner Rio Tinto offers the highest yield on the market, yet it is one of the cheapest shares of all, trading at 5.6 times earnings.
Dividend income is never guaranteed, shareholder payouts can be cut at any time. These stocks look cheap, but all have challenges in different ways. Since I plan to invest for decades, they have plenty of time to overcome them.
In total, I would like to build a portfolio of around 10-15 shares to spread my risk in case one or two underperform. If I succeed, I will be free to stop work at a time of my choosing.
