According to various sources, the average UK monthly salary ranges £2,500-£2,900. I decided to calculate how much an investor would need to put into UK stocks to earn a median £2,700 from dividends?
To get the full benefit of dividend returns, it makes sense to invest via a Stocks and Shares ISA. With an allowance of up to £20,000 a year, UK residents can enjoy tax-free dividend and capital returns from an ISA.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
But those tax benefits are useless if the portfolio doesn’t bring in any returns. Dividend returns may seem more reliable than capital gains but they’re still not guaranteed. If a company hits bad times and struggles to cover its debt, it may be forced to reduce or pause dividend payments.
These cuts can drag on for years, leaving an investor’s money tied up in useless stocks. To avoid this trap, it’s critical to accurately assess a company’s financial position and dividend sustainability.
But first, how much is needed to reach that meaty £2,700 monthly income?
Calculating returns
An income-orientated investor should be aiming to achieve an average yield of around 7%. That means they get back £7 on every £100 invested a year.
To get back £32,400 in dividends a year (£2,700 per month), the portfolio would need to be worth £462,857. Aside from winning the lottery, it would take most people a long time to save that much.
Even with a £10,000 lump sum and £300 added monthly, it would take almost 30 years to compound to that level (with dividends reinvested). And that’s assuming the yield held and it enjoyed average price growth of 3%. Still, it’s an example of what’s possible.
Stocks to consider
One good example of a stock that’s popular with income investors is Legal & General (LSE: LGEN). The insurance giant’s main draw is its very high yield, around 8%-9%. That’s well above the FTSE 100 average, and it boasts a long record of uninterrupted dividend payouts over the past decade.
Most important is that management’s explicitly committed to ongoing dividend growth of 2% a year and at least £5bn of capital returns (dividends plus buybacks) between 2024 and 2027. These kinds of policies are exactly what investors should be looking for in dividend stocks.
That said, recent dividend coverage appears weak, with payout ratios above 100% on some measures. This means cash distributions are exceeding reported earnings and could be unsustainable if earnings slip. A recent change in accounting standards could be the culprit but we won’t know for sure until things level out.
In my opinion, a solid reputation and long dividend track record are the winning factors that make it worth considering.
Final thoughts
Aiming to retire with passive income that matches the average UK salary is no easy feat. Investors will need to formulate a dedicated saving plan and stick religiously to their monthly contributions.
However, it’s not impossible, and the tax relief of an ISA offers significant benefits. Using the example of Legal & General, investors can identify other FTSE 100 stocks with similarly sustainable characteristics.
