How To Plan For Your Retirement Income

by: The Part-time Investor

I will be 49 years old in November. I just sent my last two kids off to college. My wife and I are empty nesters now and that has got me thinking about the next phase of my life, and about retirement. I expect to work for another 17 years before I retire. Maybe I'll work a few more years as a part timer, but mostly I hope to play a lot of golf. As I look towards my retirement I would like to know what my finances will look like at that time, and what I may or may not need to do differently now based on what my income will be like. In all the different investing disciplines I have looked at only dividend growth investing (DGI) allows me to do that. Index investing, value investing, writing covered calls, I have looked at them all. But none of them gives me the predictability I am looking for. By knowing what is in my account now and what yield I am getting, by taking a reasonable estimation of what my dividend growth rate (DGR) will be, and knowing what further contributions I will be making during the next 17 years, I can get a pretty fair estimation of what kind of dividend income I can expect to have when I reach 65. Based on that knowledge I can make changes in my life now, knowing what I will and will not be able to afford in retirement.

I post updates of my portfolio every quarter so people can follow along on my transactions and my progress, and so other SA contributors can give me feedback on what I have been doing. I have about $700,000 in my retirement fund right now, and over the next year it will pay me $24,346 in dividends, for a yield of about 3.5%. I hope to get that closer to 4% over the next year or so, but for the purpose of this article I will use 3.5%. I also know exactly how much will be deposited as pension contributions each year until I retire. For the next one and half years I will receive $50,000/year, and then once I hit 50 I will get $55,000/yr. I have looked at the past 5 years worth of CCC lists, focusing on the average DGR for all the dividend champions. The average 1 yr, 3yr, 5yr and 10yr DGR of all the champions usually is between 6-8%. Therefore I feel that an expected DGR of 7% per year is a safe approximation of what my portfolio's DGR will be over the next 17 years. By picking and choosing the "best" stocks from the CCC list, and using the Chowder rule as guidance, I expect my DGR will actually be better than 7%, but for the purposes of my planning I think it is a safe number to use.

So, knowing these numbers, I can calculate a good approximation of what my income should be when I retire. Nothing else will affect my income. The dividend growth rate, the yield, and the future contributions are the only things I have to take into account to figure out my future income. Changes in the stock market and specific stock prices have no bearing on the income, so there is no need to consider them in the calculations. It would be impossible to do so anyway since future market moves are impossible to predict. What I am doing here is similar to, and inspired by, what Chowder has done with his Project three million blog. But for my purposes I will not be predicting what my portfolio will be worth since I can't predict what will happen with prices in the future. Although Chowder does not predict a market return for his portfolio he does give an over-all portfolio value over time. For me that is too much at the discretion of the stock market gods. So all I am doing is figuring out what my income will be, which I believe is much more predictable.

For ease of calculation I am ignoring the last five months of this year, and jumping ahead to 2014. The DIVIDEND INCOME column shows the present dividends I am receiving. Each year it is increased by 7%. All my dividends will be reinvested, as will all my pension contributions. I plan on always being 100% invested. Therefore I take that year's dividend income and the pension contribution and calculate 3.5% of that (my dividend yield) since those funds will also start producing dividends the next year. This is shown in the ADDITIONAL DIVIDENDS column. These additional dividends are added to the next years DIVIDEND INCOME on top of the organic 7% expected dividend growth. Here are the results.

Year

Age

Dividend Income

Pension Contribution

Additional dividends

2014

49

$24,346.00

$50,000.00

$2,602.11

2015

50

$28,652.33

$55,000.00

$2,927.83

2016

51

$33,585.82

$55,000.00

$3,100.50

2017

52

$39,037.34

$55,000.00

$3,291.31

2018

53

$45,061.26

$55,000.00

$3,502.14

2019

54

$51,717.69

$55,000.00

$3,735.12

2020

55

$59,073.05

$55,000.00

$3,992.56

2021

56

$67,200.72

$55,000.00

$4,277.03

2022

57

$76,181.79

$55,000.00

$4,591.36

2023

58

$86,105.88

$55,000.00

$4,938.71

2024

59

$97,072.00

$55,000.00

$5,322.52

2025

60

$109,189.56

$55,000.00

$5,746.63

2026

61

$122,579.46

$55,000.00

$6,215.28

2027

62

$137,375.30

$55,000.00

$6,733.14

2028

63

$153,724.71

$55,000.00

$7,305.36

2029

64

$171,790.80

$55,000.00

$7,937.68

2030

65

$191,753.84

$55,000.00

$8,636.38

Click to enlarge

As I said before I am not predicting what the growth rate of my stocks will be, and therefore I am not predicting what my portfolio will be worth. I'm not trying to figure out what my $700,000 will turn into. All I am predicting is what my income will be, since that is what I will be living on. And by knowing my present dividend payments, what further contributions will be made, and using a reasonable DGR, I can predict and reasonably expect that I will be receiving about $191,000 in dividend income when I reach age 65. None of us knows what the tax rates will be at that time, but assuming a tax rate of 33% I will have about $126,000 to live on. This comes out to about $10,500 per month. This of course does not take into account any social security I will receive (if it still exists). I choose not to include SS because it's not something I feel I can rely on. So I will plan on just living off my dividends.

So now I have a pretty good idea what my monthly income will be. Knowing this, even now, 17 years before I retire, I can start seeing how my lifestyle will have to change and where I will have to cut down my monthly living expenses. This also can encourage me to change some spending pattern now to account for what I can afford to spend in retirement. For example, we bought our house during the height of the housing boom. Needless to say we over paid, and the value of the house has dropped significantly. Our monthly mortgage payment is just under $5000, and due to the drop in the value, and lack of significant equity, we are unable to refinance to a lower interest rate. If we continue to make our regular monthly payments our house will not be paid off until 2036. This is 6 years after my expected retirement date. Because of the predictability of DGI, I know I will only have about $10,500 per month of income, so it will be unlikely that I will be able to continue to afford this house payment once I retire. So I already know that I must either start increasing my payments every month NOW (or make extra payments) in order to pay off the mortgage sooner, OR I will need to downsize to something more affordable, OR I need to increase my future income by trying to increase my yield. Knowing this now, rather than being surprised by it 17 years from now, gives me time to plan for it, and perhaps gets me in the frame of mind to watch out for a good opportunity to downsize. I don't have to immediately move, but I have to consider the possibility. Of course I could sell some of my holdings once I retire to fund some of my future expenses, but as is true for many DGI'ers I want to be able to live off my dividend income, and never have to touch any of the principle.

Another example is the loans I have taken out, and will continue to take out over the next 4 years, to pay for my children's education. Between my three children the payments come out to a few thousand dollars a month. I was willing to spread these payments out well into my retirement, but now, seeing that my income will be about $10,500, using $3000 for college loans doesn't seem feasible. So I must increase my payments now, and for the next 17 years, so that these loans will not be such a burden on my retirement income. So again, the predictability of DGI allows me to plan on how quickly to pay off these loans.

As mentioned above, if I decide I don't want to cut down on my expenses, or pay off my loans earlier, another way this calculation helps me is to demonstrate whether or not my yield is adequate. If I decide that $10,500 per month is not enough for me then I can work on increasing my dividend yield trying to get my income even higher. For example, if I get my portfolio's yield up to 4%, and maintain that yield over the next 17 years, then I can expect my monthly income to be about $11,800 (after taxes). Just by modifying my portfolio yield I can get an extra $1,300 per month to live on. And if this still isn't enough (am I getting greedy???) then I can adjust the yield even more, although at some point I expect the DGR would start to suffer if I targeted too high a yield. The important point I'm trying to show is that the predictability of DGI allows me to see what my retirement will look like and therefore to make changes in my life NOW in preparation for it. As far as I know only DGI has the benefit of not only providing for my future, by giving me excellent long term returns, but also of allowing me to plan for my future.

Conclusion:

DGI has many advantages over other investing methods. To me, one of the major ones is its predictability. With most other methods you have to rely on market returns, or, in the case of covered calls, option prices. These move up and down at the will of the markets, and makes it next to impossible to know what your future will look like. But with DGI you have complete control over the yield of your portfolio and the contributions you make. The DGR is the only variable involved, but even this is much more predictable than any other market factors. By removing the variables that other methods rely on the predictability of your income is better, and your ability to make plans based on that income is improved.

Thank you for reading my article. I welcome your comments and criticisms.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.