Would you rather have £100,000 in cash or £7,075 a year in passive income forever? If you said the cash, that might be a good choice.
If you said the income, that might also be a good choice. The answer depends on a lot of things – most notably, how old you are.
Annuities
Annuities are a type of financial contract with an insurer. The firm pays you a certain amount until you die, in exchange for cash up front.
The amount depends on a few things, like your age. According to Hargreaves Lansdown, a 60-year old can expect a 7.08% annual return.
That means if you’re 60, there’s not much to choose between £100,000 and £7,075 a year. At least, not at today’s prices.
I couldn’t find a quote for a 35-year-old. But the best estimate I could find was somewhere between 2% and 4% a year.
That makes sense. Other things being equal, the insurer expects to pay for longer with a younger customer and has to factor this in.
So if you’re under 60 and you find a 7.08% a-year opportunity, take a closer look. If not, it’s worth thinking about other options.
Dividend stocks
Dividend shares are another way of earning passive income. But unlike annuities, the returns don’t care how old you are.
Ultimately, dividends come from the money made by businesses. And that doesn’t change depending on who owns them.
When things go well, the amount companies return can increase over time. With annuities, returns are often fixed.
That matters a lot. Based on 2.5% inflation, the value of a £4,000 annual return falls to £1,871 after 30 years.
Returns from annuities are more reliable than dividends. But I think income investors might realistically aim for better than 4%.
For a 35-year old, then, using £100,000 to buy an annuity doesn’t seem so great. It might be worth at least looking at what’s on offer in the stock market.
A dividend opportunity?
The stock market hasn’t been impressed with Unilever (LSE:ULVR) recently. The stock is down 21.55% since the start of March.
What’s the problem? Investors are unimpressed with Unilever’s deal to sell off its food division, but it might not be as bad as it looks.
The first thing to note is that the unit has underperformed in recent years. So it isn’t hard to see the rationale for divesting it.
Source: Company Website
The second is that it isn’t a good time to be selling food businesses. Campbell’s, General Mills, and Kraft Heinz shares this year are all evidence of this.
The firm is now concentrated in its business lines and that’s a risk. And there’s still uncertainty as to how much the deal will ultimately be worth.
I don’t, however, see the sale as a bad one. And with a dividend yield close to a 10-year high, I think the stock has to be worth considering for passive income investors.
How much do you want?
Anyone looking to invest should have an idea of what they hope to get back. And annuities are a nice opportunity for those who can get a good enough return.
Don’t, however, underestimate the effects of inflation. The effect is real and it emphasises the value of stocks with growing dividends.
Stephen Wright owns shares in Unilever.
