If you’re exploring early retirement like we were well over a decade ago, you may be wondering about the income provided from the standard 4% retirement withdrawal rule.
Does the 4% rule include dividends, specifically? Or do investors using this popular plan get to withdraw 4% annually in addition to dividend income?
The 4% rule for retirement withdrawal does include dividend payments received.
In other words, if you are withdrawing $36,000 based on the 4% rule, and you have $9,000 in dividend income, you’d only withdraw $27,000.
This $27,000 withdrawal would need to come from your savings deposits, investment income, capital gains or from the compounding of reinvested income as explained more next.
You can read more about the 4% Rule in my post Retirement Withdrawal Strategies: Do They Still Work?
Retirement Account Dividends, Capital Gains and Deposits
While it can feel like everything is all the same when you see a lump sum in your retirement account, it’s made up of five components that are important to understand.
- Initial deposits into savings over the years
- Growth from investments (called capital gains)
- Dividends that are reinvested
- Interest that is reinvested
- Compounding of reinvested dividends, interest, and capital gains
Understanding these different parts, proactive investors can affect how long their retirement savings will last.
My related article How Much Money Do You Need to Live Off Investments? explains this more.
Higher Investment Income Equals Retirement Account Longevity
As you can see from the example, the more dividends you get from your stock portfolio, the less you need to withdraw from your retirement savings deposits, bond interest, capital gains and compounding.
An investor proactively focused on creating a diversified portfolio of high dividend stocks could have a significant impact on how long her money will last in retirement. This is because the less that is withdrawn from capital the longer the retirement savings will last.
Let’s look at an example with a high dividend yield. It’s important to note that the amount withdrawn when using the 4% retirement withdrawal strategy will vary from year to year after year.
Read my related post How Much Do I Need to Invest to Make $10,000 a Month?
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4% Rule with High Dividend Example
In the example above, the retiree had about a $900,000 retirement portfolio to back into the $36,000 withdrawal.
Here’s the math:
4% Rule x $900,000 Retirement Savings = $36,000 Withdrawn Using 4% Rule
To address dividends in relation to the 4% rule, we’ll address only the stock portion of her portfolio since that is the topic of this post. Note that most accounts will also have bond interest which will increase retirement portfolio income, too.
Let’s assume Jill is using a typical asset allocation for her age and risk profile of 50% stocks and 40% bonds and 10% cash.
(My post How to Understand Your Investments explains this more if you want a refresher on asset allocation.)
The amount allocated to stocks, then, is $450,000. Here’s the math:
$900,000 Retirement Savings x 50% = $450,000
Assume the stock allocation was invested in stocks in the S&P 500 index yielding around 2%, as is common. Jill wants to retire at 60 in one year and live off investments.
In about one year, if she moved her stock portfolio to a diversified portfolio with stocks yielding 5%, her dividend income would increase to $22,500.
As a result, she would need to withdraw only an additional $13,500 from her nest egg built from retirement saving deposits, dividend income, bond interest and compounded wealth.
My related post explains asset allocation more.
Watch my related video Which Retirement Withdrawal Strategy Works Best?
But Are the Stocks Yielding 5% Safe?
It’s easy to forget that all stocks are subject to stock market risk. Bear markets come along once or twice a decade.
The last two bear markets led to stocks dropping over 50% but earlier bear markets were often less severe. I don’t know if this more radical decline is here to stay due to electronic trading or not, but I like to account for the worse and hope for the best.
It’s important to note that almost all stocks drop during bear markets. This is a risk for all stock market investors.
Read my related post How to Keep Your Wealth Safe.
Are Dividend Stocks Riskier Than Non Dividend Stocks?
Some stocks with higher yields tend to drop more during bear markets because they have more perceived risk. Other stocks drop less because they have a lower perceived risk.
“Riskier” stocks often have to pay higher dividends to attract investors. This associates higher risk with higher dividend stocks.
This perceived higher risk is offset by the fact that income stocks drop less during bear markets because they offer investors income at a time when they are not getting capital gains from stocks.
Note that bear markets eventually get back to where they were before the bear market and move higher (based on history) but seeing the value of retirement savings and net worth can be unnerving.
The good thing is that U.S. Treasury bonds almost always go up during bear markets. This is why asset allocation is so popular for passive investors.
I have written extensively about this in my post How Will a Stock Market Crash Affect Me?
Watch my related video Is Dividend Investing Worth It?
Does the 4% Rule Include Dividends Summary
The 4% rule does not include dividends in the annual withdrawal. As always, it’s important to expand beyond this simple answer with important information that can be used to reduce risk while building wealth before and during retirement.
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