Targeting a passive income from dividend-paying stocks can be a lucrative strategy at all stages of life. It’s a strategy I plan to use when I’m retired and looking for a second income to supplement the State Pension.
Is this a better option that drawing down a percentage of your portfolio each year, though? I think so, and here I’ll explain why.
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.
Drawdowns vs dividends
The problem with withdrawing cash from your ISA or pension is you’re gradually eroding your capital. This can reduce your future income potential and raise the risk of running out of money later on.
This is especially problematic if you draw down more than 4% of your portfolio each year. Another issue is you might not want to limit your income goal to such a low percentage. Realistically, it could significantly reduce one’s chances of hitting financial goals in retirement.
Let’s say you’ve been investing regularly for 30 years and have a Stocks and Shares ISA of £500,000. At this level, withdrawing 4% from your ISA each year would generate a £20,000 annual passive income. But why settle for that, when you could enjoy double that amount with 8%-yielding dividend shares?
Living comfortably
A £40,000 dividend income today, combined with the full State Pension, would provide an annual passive income above £50,000. That’s well above the £43,900 that Pensions UK says single-person households need today to retire comfortably.
So what’s the drawback? The problem, of course, is that dividends are never, ever guaranteed. What’s more, dividend shares with greater yields sometimes expose investors to greater risk — for instance, a high yield can signal a company the market thinks could cut shareholder payouts.
Yet investors can take steps to keep this risk to a minimum. Careful research to separate the dividend traps from the true income heroes is essential. So is building a diverse portfolio of 15 or more shares, covering different industries and parts of the world to spread risk.
A heroic income share
Primary Health Properties (LSE:PHP) is one of the bet shares out there for targeting a reliable passive income. I hold it as part of my own diversified dividend portfolio.
Annual dividends have risen here consistently since 1997. Not only that, but they’ve grown at a healthy annual average of 8%. The reason why? By focusing on the ultra-defensive medical sector, the rental income Primary Health receives remains stable across the economic cycle. But that’s not all — a large percentage of its rental contracts are inflation-linked, leading to steady earnings growth over time.
There’s no guarantee this dividend stock will keep on delivering. Changing NHS policy could damage demand for GP and other health services, and with it demand for surgeries and the like. But I’m confident the company will, as the UK’s ageing population supercharges demand for primary healthcare to take the strain off hospitals. It’s one of my favourite income stocks right now.
