Retirement Cash Instead of Income

By Steve Gillman

The following retirement cash idea is not so much a way to make money as a way to pay less in taxes when your funds are distributed after you retire. It is based on the fact that you are taxed not on what you take out of your retirement account, but the income and capital gains you get. Before I explain that further, lets start with a quick look at why most retirees look for income from their investments.

Buying dividend-paying stocks is a common strategy for retirees for a couple reasons. First, wherever the price of the stocks go, if the companies are solid the income keeps coming in. This provides some protection, since even if a company eventually goes bankrupt an investor who has held the stock for many years may have received everything back that he paid - in the form of dividends. Also, if he owns stocks that do not pay dividends he may have to sell some companies he likes to pay for living expenses - even when the price is down and will likely go back up.

In general, a company that pays a dividend has a stock that is less volatile. This makes sense if you think about it. A rumor could send a $40 stock down to $20, but this becomes less likely if the company is paying out a $2 annual dividend, since the yield would jump to 10% at that lower price, prompting many to buy the stock and so keep the price from falling too far. In fact, in today's market, if the company is sound, long before the stock dipped to even $30 - which gives buyers a 6.6% yield - investors would likely jump in.

However, this doesn't make a dividend paying company a better buy in the long run. It simply means the price won't swing around as much. Historically, companies that pay dividends don't do any better than those which do not - in the long run. In the short run they tend to do better during bear markets and worse during good markets. We should also keep in mind that many of today's largest companies would not be so large if they frittered away their money in dividends rather than reinvesting it into growth.

Now, if you are mentally prepared for greater volatility, there is a reason to buy companies which do not pay dividends. I'll explain with an example. Suppose you have $600,000 invested in the stock market, and most of it is in dividend-paying stocks. Your stocks average about 4% gains annually, and you collect 4% in dividend income, or $24,000 each year. That's an 8% return overall. Tax laws change a lot lately, but if at the time you read this dividends are treated as ordinary income, and you are paying the current top tax rate of 35%, you only get to keep $15,600 of the distributions you receive.

Now suppose your $600,000 is in stocks of companies which do not pay dividends, and you get the same 8% overall return on average. Of course the actual return from year to year will vary widely, and every year some of your stocks are likely to be losers. So you have some stocks that have gone up 20%, and others that have dropped by that much, and so on, but the value of your portfolio grows by an average of 8% annually. Now, what happens when you take out $24,000 each year for living expenses?

Well, if you sell only stocks that have gone down in value you owe nothing for taxes, so you get to keep the entire $24,000. That's $8,400 more retirement cash in your pocket. Meanwhile your account grows in value by $24,000 too, just as in the other scenario (in the long run - we're talking averages here). Of course, the stocks that have gone up in value will be subject to capital gains someday - if and when you sell them. Plan well and you'll pass that problem on to your heirs.

How Much Can You Make?

This question can't be honestly answered except in the most general terms. The markets go up and down, and this is not meant as a strategy to make a higher return on the investments themselves, but to make more after taxes.

Ways to Make More | Related Opportunities | Tips

You don't actually have to sell only losing stock investments for this strategy to work. You just have to be sure that you don't have a net gain on the stocks you sell. In other words, you might sell stocks that you think are over-priced for a gain of $4,000, and as long as you sell others that have lost $4,000 or more to offset those gains, you'll have no net capital gain to pay tax on.

If you decide that you want more income from your portfolio, you can choose to sell out-of-the-money options on your stocks. Many savvy investors do this to boost their returns, but you might also have to sell if the stock price rises to above the option exercise price. Also, the option income will be treated like ordinary income for tax purposes. There is a link to a page that covers selling call options at the bottom of this page.

Qualifications / Requirements

If you have an investment account at a brokerage you're ready to go.

First Steps

If you already have a retirement account with a stock broker, you can start shifting into non-dividend stocks in order to use this retirement cash strategy.

Resources

Why Buy a Stock Without Dividends? - A look at what makes a stock worth something even when it doesn't pay dividends.

Yahoo Finance - One of the best places online for tracking stock prices, and gathering information on companies.

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Sell Call Options to Boost Stock Income

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