I did a retirement scenario after reading “Why Swim with the Sharks“, now after reading “Stop Working: Here’s how you can!“, I’m going to do another analysis based on the CASH FLOW model like Derek Foster has implemented at the young age of 32.
Based on my Retiring Early article – The Expenses, I determined that my wife and I would need around $45,000(after taxes) in todays dollars to cover our expenses and discretionary spending during retirement.
The calculations are pretty simple for this one, but it also depends on what kind of assumptions that you make. In this case, I can assume that if I invest in Canadian based strong dividend companies, I can average around a 3%-4% / year in dividend income. The great thing about these companies have historically increased their dividend on a yearly basis at a greater pace than the rate of inflation.
If we were to retire early, and depend solely on our dividend income (3% dividends / year), then we would require a $1,500,000 portfolio ($45,000/0.03). If you wait for stocks to go on sale, and the yield averages out to be 3.5%, you would need a $1,285,714 portfolio ($45,000/0.035).
But wait, my calculations are before taxes, and I need $45,000 in after tax income. If I account for the dividend tax credit, and assuming that dividends are my only source of income, we would need dividend income of $23,500/spouse after taxes!
Yes, that’s right, $23,500 x 2 = $47,000, which means only $2,000 annual income tax. How? If you make purely dividend income (no other income), you get super tax breaks. In fact, if you are in any other province besides Newfoundland, you’ll end up paying even LESS tax ($600 in ON and $0 in BC)! You can try your own scenarios based on your province by using the tax calculators on Taxtips.ca.
Back to the task at hand, so if my wife and I needed a $23,500 income / investment account, assuming an dividend average yield of 3.5% we would need each non-registered investment account to be approximately $671,428 for a total of $1,342,857.
When we reach the age of 60 and 65 and CPP and OAS starting rolling in, the extra income will be considered gravy.
What are the risks involved with this strategy? I would say the main one would be inflation risk. If inflation ever gets out of control like it did in the 80’s, then inflation would eat up your dividend payments. But then again, if inflation were to go up, people would probably start selling their dividend paying stocks thus increasing the yield. Another risk is if the company decides to stop paying their dividend. This is not likely for a strong dividend company like RBC who has been paying their dividend since the 1800’s, but it is possible.
The solution to these risks? Consider having multiple sources of cash flow in addition to the dividend paying stocks for diversification (real estate etc).
- To determine your required dividend portfolio size for retirement use this formula: (Required Expenses/dividend yield) (see above for examples).
- Canadian Dividends are given favorable tax treatment, dividend income alone will be taxed very little if anything at all (varies by province and portfolio size).