As a retiree, your main financial goal should be to generate enough income through sources like Social Security, savings, and investments to keep up with your living expenses -- preferably without eating too heavily into your assets. (Hence, for example, the popularity of strategies like the 4% Rule.)
In fact, having a portfolio of assets that can generate steady income becomes increasingly important as retirees age and their ability to hold down even part-time jobs starts to wane. And that's where dividend-paying stocks come in.
A dividend is simply a portion of a company's earnings that it chooses to distribute at regular intervals to its stockholders -- and while a majority of publicly traded U.S. companies do that, plenty don't.
While that can make dividend stocks a really smart investment for people of any age, here are a few reasons why they're particularly suited to retirees.
1. Dividends can supplement your Social Security income
Many people make the mistake of expecting Social Security to provide the lion's share of their income in retirement, only to realize once they leave the workforce and start collecting the benefits that the program doesn't pay enough to cover a comfortable lifestyle. If your nest egg is smaller than you'd like, investing in dividend stocks can be a good way to give yourself an additional reliable income source that you can either use to cover your expenses or reinvest to grow your assets.
2. You'll get some protection from volatility
If you've spent your working years building up a solid balance in your 401(k) and IRA, you might reasonably anticipate that you'll be in good financial shape once you retire and start drawing down on those funds to pay the bill. But what happens when your retirement plan loses value during the inevitable periods of market volatility? If you need to take withdrawals when stocks are down, you'll be locking in losses to do so.
On the other hand, if you've invested in dividend-paying stocks, you'll have an additional income stream at your disposal that may allow you to avoid selling too heavily at inopportune times. Remember, though dividends are not guaranteed, companies with strong histories of paying them tend to continue to, even during periods when the market is crashing, the economy is stumbling, or both. As such, dividend stocks could serve as financial protection for investors when the market is underperforming.
3. You'll enjoy a better tax rate
Taxes can be brutal for retirees, who sometimes fail to plan for them to the degree that working Americans do. The good news, however, is that the IRS considers most dividends to be "qualified dividends," which means they get special tax treatment. If you house your retirement savings in a traditional 401(k) or IRA, the government will tax withdrawals from your accounts your ordinary income tax rate. But qualified dividends are taxed at a much lower rate. If you're single with an annual retirement income of at least $40,125, your marginal tax rate for ordinary income will be 22% or higher. But if you're single earning between $40,000 and $441,450, your tax rate on qualified dividends is just 15%.
Retirees are more likely than most Americans to experience financial insecurity; holding a good proportion of dividend stocks in a diversified portfolio can help shield you against it. If you're not sure which companies to start with in your income investing, check out these smart picks for retirees.
The right dividend stocks can be more than an income source -- they can provide peace of mind too. That's reason enough to consider adding them to your portfolio.