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How I’m aiming for £10,000 a year in passive income from dividend stocks

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I’d like to build an additional passive income from dividend stocks. More precisely, I’m aiming to build a £10,000 annual income. I’d like to add it to my other retirement income when the time eventually comes.

The UK stock market is home to hundreds of suitable dividend stocks that I could invest in to provide this passive income.

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The largest 100 stocks in the form of the FTSE 100 currently pay a 3.4% dividend yield. But I reckon it’s possible to achieve a much higher yield by carefully picking and choosing the best dividend stocks.

Finding the best dividend stocks

Firstly, I would filter the stock universe for the greatest dividend yields. When doing so, I notice there are some companies at the top of the list that offer yields of over 10%. I would actually ignore these. Let me tell you why.

Very high yields may not be sustainable. In my opinion, companies with dividend yields over 10% are at risk of having their dividend cut.

Secondly, I’d want to find companies I think can afford to pay the dividends. For this, I’d look for a dividend cover of over 1.5x.

Lastly, I’d like to see a decent track record of paying dividends. A company that has paid dividends for 10 years might provide more reliable income versus one that has only paid dividends for two years.

The best dividend stocks

After filtering for these criteria, I’m left with a much smaller list of dividend stocks. I’d describe it as a higher quality and more reliable list of dividend-paying shares.

For example, the top five dividend stocks in my selection are Imperial Brands, British American Tobacco, Phoenix Group, Jupiter Fund Management, and Legal & General. They’re forecast to pay an average dividend yield of 7.6%.

Of course, it would be worth looking into each of these in more detail, but highlighting them provides a good starting point.

By my calculation, to achieve a £10,000 annual passive income, I’d need to have £132,000 invested. With diligent and regular saving I reckon it’s very possible to put this amount aside over time.

Caveats

That said, I’m assuming this level of dividend yield is sustainable. It could be prudent to assume that dividends could be lowered in future, and in turn I’d need to invest more than this estimate.

Also, company profitability can change over time. Their ability to pay generous dividends could decline. If investing in individual dividend stocks, I’d need to keep up-to-date with how the underlying businesses are performing.

One more thing

But with some filtering, and careful monitoring I think I can find several high-quality dividend stocks that could provide a tasty passive income for my later years. One last point to note. With a dividend tax hike on the horizon, I’d want to make sure my dividend income is tax-free by investing within in my Stocks and Shares ISA.

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Harshil Patel has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco, Imperial Brands, and Jupiter Fund Management. 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.

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