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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to how to retire on time, a show that answers your retirement questions. Say goodbye to that oversimplified advice you've heard hundreds of times. This show is all about getting into the nitty gritty. Now that said, remember, this is just a show, should not be considered financial advice. As always, text your questions to (913) 363-1234, and we'll feature them on the show.
Mike:Let's begin. Hey, Mike. The question says, I want to use dividends as my primary source of retirement income. How would you put together a dividend portfolio? Okay.
Mike:So here's the premise of this question. There's over 10 ways you could take income in retirement. Dividend is just one. So just before we get into the details, here's just a couple of ways to consider retirement income and how it could be done. You've got first off, your encore careers, you might work part time and have a little fun doing it.
Mike:It's more purpose driven work than anything else. You've also got pensions if that's available to you. If you don't get a pension, you could choose an annuity for lifetime income. Please understand there are risks associated with that. Today's not the time to talk about that, but there are more risks than people realize when it comes to lifetime income from an annuity.
Mike:Then you've got Social Security benefits. Make So sure you optimize those, and understand when to file. That's a part of your income strategies. Then you've got other strategies, like real estate income, and you don't need to be a landlord necessarily to do that. You could do privately traded REITs, you could do Delaware statutory trusts.
Mike:I mean, there's a number of other things you could do for real estate income aside from traditional real estate. Just know your exit strategy. Then you've got other avenues like the 4% rule. 4% rule just says you're gonna take income off of the growth of the portfolio. Okay?
Mike:It's kind of the brother sister of the dividend portfolio, which is a very traditional portfolio. Now, in my opinion, and those are just some of the income strategies, there's others out there, just look for 10 retirement income strategies, something like that. You'll see my Kipling article about it. But the dividend strategy is a very popular one, and it's really intended to work as follows. You buy good quality companies that are likely to pay a dividend consistently.
Mike:That's kind of their MO. That's what they do. Think Coca Cola. Think Procter and Gamble. Think a lot of these big names.
Mike:You're you're aware of the companies. And you buy, and you just live off of the dividends. Now, in my opinion, dividends may not be as competitive as say a growth portfolio. You may lose some flexibility, but you know, it's not necessarily a bad idea. So the benefits are you could buy a portfolio, you hold the principal, you're taking income off of whatever the dividends are paid for, and your life is typically pretty simple if you're a dividend investor.
Mike:You've got more than enough to cover your needs, so there might be a little extra from the dividends. And then from the dividends, you just you spend it all as well. You maintain the portfolio, and then when you pass, your dividend portfolio then goes to your kids tax free because they get a step up in basis. That assumes that there's not any sort of estate tax issues or things like that, but very interesting and very compelling strategy, and it works. There are so many ways that can work in retirement.
Mike:This is just one of them. So now we need to divide a dividend portfolio really into, let's say, three groups, and I'm gonna call it the tax bucket groups. So you've got your dividend portfolio in your IRA account. Okay? So the dividends, they're not taxed necessarily.
Mike:They just come into the account, and then if you take the income from the dividend, then you're gonna pay taxes on it. It's just ordinary income tax. Right? Because you took a distribution from an IRA. So the IRA kind of conceals the movement or the cash flow of the dividend portfolio, but it works.
Mike:And that's fine, except for be mindful that at some point, you're gonna have required minimum distributions. If your required minimum distribution at whatever age it starts, seventy three, seventy five, depending on your age, you may need to acknowledge that your principal, what you're holding as a dividend investor, the dividend distribution may be greater than the RMD, and now you're having to move assets from your IRA to your Roth. Now you can do that without selling positions. You can kind of slowly hack away at this. If you're a dividend investor, and most of your assets are in IRA or pretax accounts, be mindful of the subtle conversion from IRA to Roth.
Mike:Because you don't want your principal or your income eaten away at taxes because of required minimum distributions. Now the second part of this, let's say the Roth. The Roth is nice. If you can slowly get things in there at some point, then you're kind of in a good situation because you're getting the dividend. You then can spend it tax free or reinvest it.
Mike:There's really a nontaxable situation at this point. So that's kind of the goal. And by the way, RMDs don't count for Roths. It's just pretax. A lot of people will miss that point.
Mike:So there you go. Now the third group is your brokerage account. A lot of people, let's say business owners, they'll go in and they'll sell their business. They get everything non qualified. That means it's not a retirement account.
Mike:That, by definition, is not an IRA or not a Roth. You may have assets for retirement, but for it to qualify as a retirement account, it's really an IRA or Roth. That's just kind of a technical bit there that you'll need. But if you're in a brokerage account, I've never had someone ask for this. But listen up.
Mike:This is really, really important. Okay? If the majority of your assets or even some of your assets are in a brokerage account, as in you're paying taxes if you sell the position that's long term or short term capital gains, or you're receiving income from the dividends, so you get the dividend and you're gonna pay taxes on it, you need to understand what you're invested in. On your ten forty, this is what you write down. This is what you go home and look at.
Mike:On your ten forty, your tax return for last year, look at line three. On line three, you've got three a, and you've got three b. Three a is for qualified dividends. Anything that's in there, foreign entities count for this. Some US companies will count for this, Depending on how you invest may count for this.
Mike:There's a lot of nuance in this. But if you invest in the right places with the right companies that qualify for this, and you hold it for a long enough period of time, you can have qualified dividends as your income. Why does this matter? Because a qualified dividend is taxed as long term capital gains. So if let's say you're married and you filed jointly, for the first $96,000 or so of income, zero taxes.
Mike:So when I think of dividend investors, I really don't recommend it often. I mean, I'm not making a blanket statement recommendation here. But if you have IRA assets, you can do a lot with an IRA asset portfolio or IRAs and Roths. But for those who are kinda stuck with nonqualified assets, making sure that you invest in either ETFs and or stocks, stocks that would qualify, so companies that qualify, so that you can get qualified dividends. It can be a huge tax savings.
Mike:Huge. Because if you don't, if you invest in, let's say, aggressive ETF dividend portfolios, you're gonna get taxed as ordinary income. Yeah. The first little bit's 10%, then you got 12%, then you got 22%. And if you're taking Social Security along with this, it's not very tax efficient when the Social Security bumps you up at some point, and then you've got then your 22% tax bracket.
Mike:I'd rather pay zero to 15%, then ten, twelve, and then 22% on the your effective tax rates. So be very mindful of, and here's what I've never heard. No one's ever my fifteen years of working in the retirement services space, no one's ever come to me and said, hey, Mike, look, I want a portfolio, and in that portfolio, I wanna make sure I only invest in ETFs or companies, so I can get qualified dividends. It's never happened. It's one of those things that you don't know to ask for, but you assume the financial professional would know this.
Mike:It's hard when you can't give tax advice, and you're not looking at tax code. It's hard if you're a financial adviser, and you're not looking at the details on how it's gonna affect their plan. How it affects their income. Because your job is to find good investments. Well, if it's not good tax efficient investments, and if you're not trained to do this, it can be kinda tricky.
Mike:How do you create a dividend portfolio that favors qualified dividends so that your income from the dividends are more focused and lean towards long term capital gains. Now the idea is simple. You wanna buy and hold the dividends because if you're manipulating, if you're trading things out, I don't know the official rule, but it's like the sixty one day qualified dividend rule or something like that. You could Google it, ask your favorite AI about this. But you have to hold it for a certain period of time, and there's restrictions between when the dividend was paid, and when the next dividend will be paid, and how all that works.
Mike:So there may be a tricky transition into this. So the first year you build out the dividend portfolio, there might be a few bumps along the way. That's okay. But in the second year and beyond, if implemented correctly, no problem. Really cool situation.
Mike:Now your bear market protocol, that's the protocol for not if, but when the markets crash, and then the situation when dividends stop paying, what are you going to do? That's why it's a protocol. It's a system. It's not sentiment. We're not gonna wing it when it happens.
Mike:You need to understand that dividends will be cut during difficult times. So if you're a dividend investor, you have to ask yourself, where can I pull money for a temporary period of time that would allow me to coast through so you're not selling the principal of your dividends or your dividend stocks, your blue chip stocks as many will call it? And here's just a simple idea. I'm not saying this is the right idea for you. I'm just saying this is an idea.
Mike:But you could look into something like a buffered ETF. So you've got a significant buffer that's a protection or a version of protection. May not be a 100% protected, but maybe the first 60% or so is protected, first 50% of losses is protected, something like that. You treat it kinda like a dividend that each year, it grows. You take a little bit off the top, so you're still collecting some income from it.
Mike:But then when the markets crash, you can tap into it without accentuating losses, as long as you're selling it around the anniversary date of the buffered ETF. But it's a way that you can sail through market turbulence whenever dividends get cut, without accentuating your losses, and without selling your principal. That's not what you're supposed to do when you're a dividend investor. You wanna not touch your principles. So just be very very mindful of that.
Mike:And then as you set this all up, also be mindful about when are you gonna retire? When do you want your dividends you're gonna start collecting dividends instead of reinvesting them? How does your income line up? What's your tax minimization strategies that are needed? Most people don't have everything in one tax bucket.
Mike:There's usually a little bit in your IRA, a little bit in your Roth, a little bit in your brokerage account. So just be aware of the movements that are needed long term for your tax planning, and then coordinate your Social Security along with all of this. You might push out Social Security to do some tax planning so that your RMDs are not an issue when they start, and you're still the dividend investor. So the number one thing I would typically start with in this conversation is looking at the brokerage account and identifying is your investment, is your ETF or your stock giving you qualified dividends or ordinary dividends? And what if you could move some of the ordinary dividend ETFs, typically they're ETFs, At least that's what I found.
Mike:Could you sell some of them and move those funds over into more tax efficient versions of those kinds of dividends? And then do an analysis. Are you gonna get less cash flow because you're in qualified dividends, Or is it fine? Is there a tax efficiency? You need to do a comparison because it's not always one or the other.
Mike:Everyone's gonna be different. Dive into the details. You got this. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcasts.
Mike:Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date, go to www.yourwealthanalysis.com today to learn more and get started.