Retirement should be about keeping your income steady and stress-free. The secret? Make smart financial moves that maximize returns while minimizing taxes.
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Dividend stocks pay regular income to investors from a company’s profits, offering retirees a steady cash flow. GOBankingRates spoke with Gil Baumgarten, wealth expert and president of Segment Wealth Management, to learn why dividend stocks can be a game-changer for retirement income.
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Dividend Stocks Offer Stability
Dividend stocks can offer stability, but selecting the right ones is essential. “High dividend stocks (over 4% annualized yield) tend to be more stable in price and lower in overall return than other stocks,” Baumgarten said. However, high yields can sometimes signal corporate stress, so yield alone shouldn’t be the primary focus.
Instead, Baumgarten suggested looking for companies with “low but rising dividends,” which often signal strong financial health and better growth potential over the long term. These stocks can offer both stability and favorable after-tax returns.
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Maximize Tax Efficiency With Blue-Chip Stocks
When it comes to taxes, dividend stocks hold a distinct advantage for retirees. Blue-chip stocks (those issued by prominent, well-established companies) or exchange-traded funds (ETFs) made up of blue-chip stocks “tend to offer rising dividend payments to shareholders and compound the gains in share price over time,” Baumgarten said.
The real advantage comes with what’s known as “unrealized” gains. These are gains that accrue as the stock price rises but are not taxed until sold. Under current U.S. tax laws, stocks held until death often qualify for a tax-free “step-up in basis,” eliminating accumulated capital gains over decades.
For retirees, holding onto these investments for the long haul can result in significant tax savings. Unlike some other income strategies, where gains may be taxed at each transaction, dividend stocks allow retirees to defer and minimize taxes.
The Tax Perks of Patience
One major tax advantage of dividend stocks is their capped tax rate. Ordinary dividends are taxed at a maximum of 23.8%, roughly half the top tax bracket rate. However, the real benefit is the potential for tax-free growth.
Baumgarten warns against frequent stock trading or portfolio churn, “Transactional methods to swap one stock for another can render much higher taxes.” He adds that this strategy also risks triggering taxes on gains that might otherwise be avoided, creating “a hurdle to overcome, arguing for extreme patience.”
By holding onto dividend stocks and letting the share price grow over time, retirees can avoid paying unnecessary taxes and allow their investments to compound. The key is to resist the urge to frequently trade or cash in dividends for short-term gains.
Prioritize Financially Healthy Companies Over High Dividends
Some retirees might find comfort in regular dividend checks, but Baumgarten suggests reinvesting these dividends as the smarter long-term approach. “Many investors find comfort in big mailbox checks that get re-deposited and never spent,” he said. However, this cycle can generate more overall taxes.
In other words, opting for lower-yield stocks from healthy companies and holding onto them for the long term can lead to greater wealth accumulation. The potential tax savings from long-term stock growth, combined with lower dividend payouts, can ultimately provide more financial security in retirement.
Dividend Taxes: The Bigger Picture
Dividend taxes are often debated, with critics claiming that lower rates mostly benefit the wealthy. Baumgarten counters that dividends are taxed twice: “Companies pay corporate income tax of 21% on the same dollars before they are distributed to shareholders.” Add in the personal tax on dividends, and these profits can be hit with a total tax rate of over 40%.
Baumgarten’s solution? Advocate for more people to become shareholders. While dividend stocks offer undeniable tax benefits for those who invest, the bigger picture involves educating more people about these opportunities to grow wealth for the long term.
A Smart Play for Retirement Income
For retirees seeking income growth and tax management, dividend stocks are a smart strategy for stability, growth and tax efficiency. With the right dividend stocks and a patient approach, retirees can strengthen their financial outlook while minimizing tax burdens.
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This article originally appeared on GOBankingRates.com: How Dividend Stocks Can Supercharge Your Retirement Income
