Living off the State Pension in retirement could prove to be more challenging than many people realise. It amounts to just £8,767 per year, which is less than a third of the average annual salary in the UK.
However, since 35% of people do not currently have another pension plan in place, living off the State Pension in retirement may become an increasingly likely prospect.
This, though, does not need to be the reality for anyone. Whether you have decades until retirement, or it is just around the corner, investing in dividend stocks could provide a worthwhile second income to supplement the State Pension in older age.
Although dividend stocks may have a reputation for being slow-growing and defensive companies, this is not always the case. There are a number of FTSE 350 stocks that offer yields which are significantly higher than inflation, and yet are forecast to post strong earnings growth over the long run.
In fact, a company’s ability to grow its dividends could have a major impact on its share price performance. Not only could a rising dividend attract income investors, the stock market may upgrade companies that have the confidence to increase shareholder payouts. It may signal that their management is upbeat about their future prospects, and that their financial outlook is improving.
Furthermore, with various studies having shown that the reinvestment of dividends received can have a significant impact upon a portfolio’s total returns in the long run, focusing on good value dividend stocks with growth potential could be a means of generating a nest egg by retirement.
Even if a retiree has a nest egg that they feel may not be as large as they had hoped for, the FTSE 100 currently offers a wide range of stocks with high yields. The index itself has a dividend yield of around 4.2%, which is higher than its long-term average. Therefore, it may be possible to generate a surprisingly high income from even a modest nest egg.
Furthermore, there are many FTSE 100 stocks that offer yields in excess of that of the index. Therefore, a retiree may even be able to build a diverse portfolio of shares that have an average yield of over 5%. If this is achieved, they would require a nest egg of around £175,000 in order to double their State Pension.
While investing in shares carries risks, the potential returns are much higher than those available in Cash ISAs or in buying investment-grade bonds. While buy-to-let investing has been a popular source of income in older age, tax changes have made it less profitable for many landlords.
Therefore, dividend stocks could offer a worthwhile balance between risk and reward, as well as between growth and income. With the FTSE 100 appearing to offer good value for money, now could be a good time to buy a range of large-cap income stocks.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.