I reckon UK dividend stocks are possibly the best way to generate passive income in retirement. Better still, I can take that tax-free inside my Stocks and Shares ISA portfolio. Here’s how I’m going about it.
To generate around £800 a month in tax-free passive income, I need ISA savings of £240,000. How do I know that? Thanks to an often overlooked investment benchmark called the 4% rule. Put simply, this states that if I withdraw 4% of my retirement portfolio as income each year, my pot will never run dry.
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.
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How I’m building a passive income for retirement
The 4% rule assumes average investment growth of 7% a year, including dividends. If I withdraw 4% a year and inflation averages 3%, my portfolio will stay roughly the same size. Of course, none of those figures are guaranteed, but a target of £240,000 in ISAs looks just about doable, at a stretch. And 4% of that is £9,600 a year, or £800 of monthly passive income. It’s not riches, but it’s better than relying purely on the State Pension.
So much for rules. I will also have to knuckle down and build enough ISA savings to generate my target income. There’s still a way to go, but I’m taking advantage of current stock market volatility to top up my portfolio. I need to act fast, because the annual ISA deadline is just one month away, at midnight on 5 April.
The FTSE 100 is one of the best stock markets in the world for dividends, and I’m underpinning my portfolio with a couple of top equity income funds. I’m a long-standing fan of the City of London Investment Trust, and it’s about time I bought it. Its current yield is a rather splendid 4.48%. The ongoing charge is just 0.38%, so I’d get to keep most of that juicy passive income for myself.
I’m also investing in FTSE 100 stocks
City of London has even started to generate some growth, as the FTSE 100 swings back into favour, rising 15.4% in a year. I’ve been investing in the Rathbone Income fund for years. Its yield is lower at 4.06% and charges are higher at 0.75%, so I may rethink this choice, but it has grown steadily for the 15 years I’ve held it, and I’m reluctant to let it go.
To generate the rest of my passive income, I would look to build a portfolio of individual FTSE 100 stocks. I like the look of Lloyds Banking Group right now, as rising interest rates should boost its net lending margins. Yet it still trades at a dirt-cheap P/E of just 6.1 times earnings. The dividend yield is now 4.34%, and I expect that to continue climbing.
Oil giants BP and Shell are rising along with the oil price, and I’d buy them both, along with passive income heroes including mining giant Rio Tinto, financial firms M&G and Phoenix Group Holdings, housebuilder Persimmon and mobile phone operator Vodafone.
Of course, I have to remember that each of these stocks comes with risks, both sector- and company-specific. But I feel that owning a basket of them mitigates some of the risk for me.
I hope that the 4% rule will serve me well when the time comes to retire.
