I posted my goals for 2016 a few weeks ago. After some changes that I became aware of subsequent to posting the article, I have some changes. I have had some change in plans about my goals for 2016. I have decided to essentially live off dividends in 2016. I will be spending my dividend income that comes from my taxable accounts. My annual expenses are close to $18,000 – 24,000/year. My taxable dividends are approximately $10,000 - $11,000/year ( out of $14,000 - $15,000 in total dividend income). The shortfall could be covered by any side income activities I engage in.
I have decided to try and save my entire paycheck in 2016, after taxes of course. I will manage to do that by taking the maximum contributions to my 401 (k) and Health Savings Account (H S A) plans. After speaking with several reps at my 401 (k) administrator, I learned that I can make after-tax contributions, which can be converted to Roth. I already plan to max-out my 401 (k) with pre-tax money, which provides me with an instant tax break. I also receive an even larger tax break in my investment through my Health Savings Account. Any after-tax money I manage to put away will be converted to Roth on a few occasions throughout the year. This means that under current legislation, any earnings derived from that money will never be taxable. I would not be opposed if a larger portion of my net worth is held through tax-deferred assets, and therefore any dividends and capital gains would be deferred.
The total I can contribute to a 401 (k) in 2016 is $53,000. This includes my pre-tax contributions which are limited to $18,000, my employer match and any after-tax contributions I make. The sum of the three items listed above cannot exceed $53,000 for 2016 for individuals who less than 50 years old. Since I don’t earn a lot, and since I will have to pay some taxes on income, I may not be able to hit that whole amount. Yet, it may be worth trying. Paying taxes on dividends and capital gains is a drag in the accumulation phase, which slows down the process of accumulating that very same nest egg to live off in retirement.
The sad part about all of this is that I won’t be able to put much new money to work in dividend paying stocks. I will be reinvesting dividends in tax-deferred accounts and mostly spending them in taxable accounts.
Since the 401 (k) money comes right out of my paycheck, I will be investing automatically twice per month. My 401 (k) is invested the following way ( which is due to options available to me and not a recommendation to you, since I have different objectives and goals and experience than you).
60% Large Cap Index Fund (S&P 500)
20% Small/Midcap Index Fund ( Russell 2000)
20% International Stock Index Fund (EAFE)
Over the long-term, a portfolio of index funds will likely generate similar results as a diversified portfolio of dividend growth stocks. If you add in the tax advantage however, you can see that investing in mutual funds makes a slightly better sense today. The other advantage of 401 (k) plans is that they are protected from all forms of creditor judgment, whether it's the result of, say, a bankruptcy or a personal-injury lawsuit. This is an appealing feature, which provides a level of protection that taxable accounts do not.
I believe that this move will be beneficial in the long-term for me. This is because I will be able to Rothify a large portion of my portfolio, and ultimately will have much less in tax liabilities than investing in individual companies through a taxable account. In addition, having money in a tax-deferred account is helpful in eliminating tax waste during the accumulation phase. As I said before, I may continue doing what I am doing now even after I hit the dividend crossover point in 2018. Therefore it makes sense to keep most of my assets in tax-deferred accounts.
Once I do decide to retire however, I will convert those mutual funds into a diversified portfolio of dividend growth stocks. I still believe in the dividend growth stock strategy as a way for a retired person to live off their assets. We all know that dividend income is more stable than capital gains, which is evident when the stock markets around the world are crashing. For now, most of my assets are in dividend growth stocks. As I invest most of my money in a 401 (k) however, I will likely end up owning more assets there than through individual investments. Under current legislation, this will also provide tax benefits on investment income to those family members that inherit the assets as well.
I still have a lot to say about dividend growth investing on this blog. I like to analyze companies I own or would like to own in the future, and also think about different ways to utilize my capital for its best use. I also think about different ways to improve my finances all the time.
For example, when I invest in my Roth IRA in 2016, and potentially SEP IRA in 2016, I will be able to buy shares in individual dividend growth stocks. I am seeing a lot of companies where I want to build out my positions selling at better entry valuations than before. I am interested in more 3M (MMM), Accenture (ACN), United Technologoes (UTX), Exxon Mobil (XOM), ACE Ltd (ACE), Hershey (HSY), McCormick (MKC), General Mills (GIS) etc.
Full Disclosure: Long all stocks listed above
- Taxable versus Tax-Deferred Accounts for Dividend Investors
- My Goals for 2016
- Should taxes guide your investment decisions?
- Dividends Provide a Tax-Efficient Form of Income
- My Retirement Strategy for Tax-Free Income
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