Living off Dividends (How Much Is Needed?)

The dream of living off your dividend payments and sipping on Pina Coladas down at the beach is a goal for plenty of people.

Now the real question is how much is needed in investments to achieve this goal?

The main input would be the following:

-How much would you require to live the life you want (this would factor in cost of living for an area and how of a lavish lifestyle you would like to have)?

So let’s say hypothetically the number is $100,000/year (married filing jointly tax status) as a in order to live the life that was wanted. It’s important to remember about taxes (I know it sucks, but it’s part of life), as that would cut into how much in gross dividends would need to be collected.

Taxes

There is a good article on Nerdwallet that goes over the details of all the tax situations.

 https://www.nerdwallet.com/blog/taxes/dividend-tax-rate/

The most important distinction when it comes to taxes and what you pay is whether or not the dividends are considered ordinary or qualified.

If they are ordinary, then the tax rate would be based on the federal income tax brackets. If they are qualified, then the tax rate is based on long term capital gains tax brackets.

For this post, the assumption is you have been holding the stock in a US based company for a long enough period to qualify for the qualified status. Also good to remember is that if you have a Roth 401k or IRA, then the dividends wouldn’t be taxed at all!

Okay so we established these are qualified dividends in the situation.

I attached a little excel calculator that allows a couple inputs to shoot out whether or not a certain amount invested, with the tax status, dividend type, investment account type, and the dividend yield required would allow you to have reached the hypothetical goal.

As you can see there are lots of gives and takes in order to back into the required amount needed to generate a desired after tax result. 

In this case having $2,700,000 with a 4% yield would get you there. Now I am not smart (or at least couldn’t think how to do it) enough to figure out how to build the formulas to tell you the amount needed to invest based on after tax income and yield alone. 

The higher the yield, the less invested is needed. One issue though is value traps or yields that are not sustainable. That’s why looking at things like payout ratio (dividend % of total net income) or the free cash flow payout (dividend % of total free cash flow) is good. 

Also none of this factors in that a company with a lower dividend but is growing may also increase their dividend overtime. In this scenario, we are talking about not having to touch the principal and that the yield will remain constant.

So it is more of a plug and play type model or you can try to run a goal seek in excel 🙂 (attached at the bottom of the post)

For those that are really new to this kind of stuff, you may be wondering what yield is?

Essentially it is a % that you would receive back in dividends based on the stock price you paid for the shares. Taking a look at a real life example with something like Verizon which shows a forward dividend payout of $2.51/share.

That means that you would take $2.51/ $58.97(current price) to come up with a yield of 4.26%. So if a $100 was invested, you would get paid $4.26 worth of dividends on a yearly basis (quarterly payments).

When it comes to yields it is all about when you purchased the stock as if the stock goes down to $50 tomorrow, whoever buys at that point has locked in a yield of $2.51/$50 which would be a yield of 5%.

So although the yield when you look at a website like yahoo finance fluctuates, the yield you receive would be based on your purchase price of the stock (not the current market price).

For me dividends aren’t my main focus when I’m younger as I care about real returns (price appreciation + dividends) and only looking at dividend plays may underperform the markets. Now for those trying to generate cashflow or income, then dividends is one avenue of getting there.

Hope that helped you understand a little more around dividends and how much would be required in order to truly live off them 🙂

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