Where to look for income

As Capita points out, the upshot is that UK income-seekers are now dependent on just five companies for nearly half of their income. Those five are BP, Shell, HSBC, Vodafone and GlaxoSmithKline. Between them, they increased their dividends by 8 per cent in 2009. There were few surprises in the next 10 either, almost all companies in defensive sectors such as tobacco, brewing and utilities. In total, these 15 companies accounted for more than two-thirds of the total payout, with defensive companies increasing payments by 5 per cent. Cyclical companies, meanwhile, slashed their dividend payouts by a quarter.

But, as we've pointed out previously, we can't rely on these defensive sectors to continue increasing their payouts at the same rate. Oil and gas producers, which account for a whopping 26 per cent of UK dividends, are expected to increase their dividends by a mere 1.8 per cent this year. BP, for example, recently held its dividend. Likewise, mobile telecom – or, more accurately, Vodafone – is expected to rein in dividend growth this year, to 3.6 per cent.

While we may see a rebound in payouts from cyclical sectors, their payout ratio is set to remain well below the market average of 3.6 per cent. Take Xstrata, for example, which reinstated dividend payments to much fanfare, but still yields less than 1 per cent. And with dividend increases failing to keep up with last year's share price recovery, the projected yield for 2010 is just 3.4 per cent, below the 3.9 per cent payout in 2009 and well below the 4.2 per cent paid out a year earlier.

Taking these figures at face value suggests grim times ahead for the UK's equity income enthusiasts, especially UK income fund managers who are finding it more and more difficult to put together a diverse UK income portfolio. Sarasin notes that dividend concentration is much lower in other markets – less than a third of dividends come from the top 10 stocks in Europe, the US and Japan. Put simply, this means there is more diversification available on a global basis, enabling dividend hunters to mitigate against sector risk as well as country risk.

Foreign dividends not all sunshine

Although the case for chasing overseas income is a strong one, buying and holding European income shares is not without its risks.

■ Currency risk: Currencies have been extremely volatile of late and this is a factor that anyone considering an overseas income excursion would be wise to take into consideration. Sarasin recognises this, which is why it offers both hedged and unhedged exposure to global equity income, but private investors can hedge, too, using tools such as covered warrants.

With the pound under huge pressure at the moment and genuine fears of a sterling crisis mounting, maybe the greatest currency risk of all is not tapping into non-sterling income streams. Mr Monson at Sarasin notes that 65 per cent of all UK earnings come from abroad and 40 per cent of UK earnings are paid in dollars. And while the current weak pound means you now won't be able to get as many overseas shares for your money, it could buy you even fewer if you wait too much longer.

■ Taxation: Mr Monson admits that tax treatment is still messy in terms of dividend reclaim, international offset and how withholding tax is treated. "We've had two changes within the last three months from individual countries. So, while the companies are doing well, governments are doing less well in allowing that dividend income to flow through."

So, before buying foreign shares for dividend investment, make sure you've filled out the right paperwork, such as Form W-8BEN for the US, which would otherwise automatically apply a 30 per cent withholding tax to overseas beneficiaries of US dividends. This ensures that foreign recipients will instead be charged the maximum 15 per cent withholding tax as agreed under most developed countries' Double Taxation Agreement. Interestingly, while Singapore can charge a 15 per cent withholding tax under the treaty, its current rate is zero.

Taxation on dividends is a complicated business, so make sure your broker knows their way around foreign markets and, if in doubt, hire a good accountant.

Don't bank on bonds for income

Bonds was the place everyone wanted to be during the credit crunch, in particular government bonds which offered safe and steady income streams in a low-interest world.

But, as the examples of Greece and Ireland have shown, sovereign risks are mounting, and . The attraction of corporate bonds is waning, too. As Alex Stewart at Evolution points out, although a "reverse yield gap" where equities yield less than bonds has become more common in the past 30 years, there are nevertheless a vast number of companies who now offer a dividend yield well in excess of the corporate bond. He identifies 300 companies across Europe that offer yields better than their national government paper. While in the past this could have signalled the prospect of dividend cuts, Mr Stewart does not believe this is now the case, and that we could in fact be seeing "a huge buy signal for the equity over the bond".

Guy Monson at Sarasin believes there could be a huge flow of cash from bonds into those equities which offer solid yields. "We're picking up a very fundamental shift in asset allocation. We're finding our clients switching, some of them permanently, as a source of long-term income growth," he says. He points out that equities have been persistently derated for a decade and, while this is starting to turn, equities remain 50 per cent undervalued versus bonds. Mr Monson thinks that the massive accumulation of foreign reserves in emerging markets has forced this money back into government and corporate bond markets, and distorted its normal relationship with equities.