The FTSE 100 is forecast to pay out £78.4bn in dividends in 2017 – £4.6bn more than the forecast rate in 2016, according to research by AJ Bell.

While this equates to a yield of 4.2%, much higher than the 1.39% yield from a 10 year UK government bond and 1.51% from the best fixed rate cash ISA, it said the 1.46 times dividend cover looks “worryingly thin”.

Half of the dividends from the FTSE 100 are forecast to be paid out by just seven companies:

• BHP Billiton – £421m
• Lloyds – £393m
• Standard Chartered – £343m
• Glencore – £337m
• Rio Tinto – £306
• British American Tobacco – £272m
• Anglo American – £259m

Plus, the top 10 FTSE 100 companies forecast to have the highest dividend yields have an aggregate cover of just 1.17 times, yielding an average of 6.9%.

There are 17 FTSE 100 firms that are forecast to yield in excess of 3% in 2017 and have a dividend cover of 2.0 (the ‘sweet spot’ where profit is double the amount a company is paying out to shareholders).

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EasyJet is the only one of these that is not forecast to grow its dividend in 2017, having just pushed through a dividend cut for 2016.

Russ Mould, investment director at AJ Bell, said that dividends have accounted for 74% of total returns from the FTSE 100 over the past 30 years so they’re an important consideration for all investors when choosing which companies to invest in, particularly those looking to generate an income from their portfolio.

“With income being such an important consideration for many investors, particularly those in retirement, it can be tempting to simply seek out the stocks that are forecast to pay the highest dividend yield.  However, it is important to also assess whether the dividend yield is sustainable by looking at dividend cover and whether the dividend is growing.”

Mould explained that dividend cover is the amount of profit a firm makes divided by the dividend it pays out to shareholders.

“Divided cover of below 1.0 should ring alarm bells because it means the company is paying out more to shareholders than it makes in that year. This means it has to dip into cash reserves, sell assets or borrow money to maintain the payment.  This is unlikely to be sustainable over the long term.

“Dividend cover of around 1.5 is less than ideal because it means a company has less room for manoeuvre if profits fall in one year.  It will then need to decide whether to reduce its dividend, stop reinvesting in the business or take on more debt.

“Dividend cover of 2.0 or above is ideal because it means profit is double the amount the company is paying out to shareholders.  This means it can continue to invest in the business and has scope to maintain its dividend payment in a bad year.”

Funds for income-seeking investors

Ryan Hughes, head of fund selection at AJ Bell suggests four funds that income seeking investors could consider:

Artemis Income – 4.3% yield

This fund has been one of the most consistent funds in the equity income sector over the past decade with experienced fund manager Adrian Frost expertly navigating almost everything markets have thrown at him over this period. The fund is well diversified and looks to produce a rising income ensuring that it focuses on companies that offer dividend growth rather than just an outright high yield.

Woodford Equity Income – 3.5% yield

Managed by one of the most successful fund managers in the UK over the past 20 years, Neil Woodford needs little introduction. His long-term approach and comfort in not following the herd has been instrumental in his success and this has also allowed him to allocate to small and unquoted companies with a level of patience lacking from so many of his peers.

Invesco Perpetual High Income – 3.3% yield

Following in the footsteps of Woodford is no easy task but Mark Barnett has managed to successfully do just that since he took over management of the High Income fund. Through a focus on large, higher yielding companies, Barnett has delivered strong long-term performance with a consistently high income. In addition, Barnett is comfortable looking outside of the UK to further diversify the portfolio if appropriate.

Montanaro UK Income – 3.6% yield

For someone interested in looking away from the large companies, smaller companies in the UK offer good levels of income, often with decent dividend cover. One way to access this is through the Montanaro UK Income fund which is run by one of the largest independent dedicated small cap teams in Europe. With a simple approach that focuses on high quality companies that are growing and managed by strong management teams this fund offers an interesting way to generate income for your portfolio from a very different part of the market.