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Dividend shares are an excellent way to earn passive income, in my opinion. Investors can build up a Self-Invested Personal Pension (SIPP) during working years, then withdraw regular dividend income once they turn 55. Although, this pension age is expected to rise over the coming years.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Some companies distribute a portion of their profits to shareholders in the form of dividends. Typically, this occurs quarterly or semi-annually. It’s a reasonable way to earn passive income as investors can receive regular dividends without having to sell any shares.
Also, dividend investors can ignore the daily ups and downs of share prices. The best dividend shares have a strong track record spanning many decades.
This stock pays a 9% yield
One example of such a share is Legal & General (LSE:LGEN). Its shares are attractive to income investors due to its 9% dividend yield. This is much greater than the FTSE 100 average of around 3%–4%.
Often, though, a high yield might not be the most reliable. But L&G has a strong record, supported by robust cash flows. In fact, it has paid a dividend every year for at least 35 consecutive years. It has also managed to increase its payout annually for the past 15 years.
Its revenue streams are diverse and include insurance, investment management, and retirement products and services. This spread of business areas provides resilience.
Bear in mind that L&G would be considered a defensive play. And although it has been an excellent source of dividends, its share price has lagged the average FTSE 100 share. And although it’s an excellent source of dividend income, investors might want to consider pairing it with more growth-oriented shares. Particularly if retirement age is far into the future.
£1,500 in passive income
To target £1,500 a month of passive income, that equates to £18,000 a year. If an investor owns dividend shares like L&G that offer a 9% yield, I calculate that they would need a total SIPP worth £200,000.
But as a 9% yield is at the higher end of the range, so crunching the numbers based on a 6% yield would be more conservative. Note that if the SIPP earns 6% a year in dividends, the pot would need to be £300,000.
This might look like a substantial sum, but by investing regular sums over many years it can become a lot more manageable.
For instance, including dividends and capital growth, the long-term average stock market return is around 8% a year. Given this rate of return, I calculate that an investor could build a pot worth £300,000 by regularly investing £345 a month for 25 years.
Don’t forget about inflation
Also, note that a £1,500 a month income in the future will likely not provide the same value as £1,500 today. The price of goods, services, and living costs are likely to rise. That’s why it’s important to consider the effects of inflation.
Overall, an investor looking for passive retirement income in the future should consider a diversified portfolio of both dividend and growth shares. Starting as early as possible should also help in reducing the burden of building a sizeable pot.
