Dividend ETFs, The Fiscal Cliff And Potential Tax Hikes

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 |  Includes: DLN, DVY, SDY, VYM
by: Tom Lydon

If we witness another political gridlock going into the "fiscal cliff" next year, investors may see a hefty tax hike on dividend-paying exchange traded funds. Nevertheless, dividend investors shouldn't jump ship too quickly as the alternatives are still rather lackluster.

Dividends received will be taxed as ordinary income after Jan. 1 if Congress lets the bush-era taxes expire, with a maximum 39.6% rate, plus a new 3.8% tax to pay for the healthcare reform, reports Jonathan Burton for MarketWatch.

Additionally, capital-gains tax rates, which have typically been half that of the income tax rates, will rise to a maximum 20% come Jan. 1, as well.

While investors would have to pay more for their dividends, dividend-generating stocks and ETFs are still much more attractive than the alternatives.

"Where are you going to put that money?" Howard Silverblatt, senior index analyst at S&P/Dow Jones Indices LLC., asked in article. "Competitively, I don't see what's going to take dividends' place. On a risk-reward basis, these are still attractive rates."

"Income is very low and hard to come by," Daniel Peris, co-manager of Federated Strategic Value Dividend, said in the article. "A dividend-focused strategy, even on a higher-tax basis, still compares favorably to the alternatives."

The benchmark 10-year Treasury notes yields around 1.67%. The S&P 500 Index yielded 2.25% at the end of August.

Dividend stocks gained 14.4% annually between 1979 through 2002, compared to the 11% return for non-dividend providers.

Only households that earn over $250,000 a year or single filers with more than $200,000 will have to pay the maximum 43.4% tax rate on dividends. Additionally, most dividend-paying assets are in tax-deferred accounts.

"There always seems to be this implication that everybody is going to pay the top marginal rates, and that's not true," Josh Peters, editor of investment researcher Morningstar, added. "If the bulk of your retirement funds are in tax-deferred accounts, don't worry,"

Todd Rosenbluth of S&P Capital IQ offers a few ETF suggestions for those still seeking dividend investments:

  • SPDR S&P Dividend (NYSEARCA:SDY): 3.14% yield
  • iShares Dow Jones Select Dividend Index (NYSEARCA:DVY): 3.41% yield
  • Vanguard high Dividend Yield Index (NYSEARCA:VYM): 2.79% yield
  • WisdomTree LargeCap Dividend (NYSEARCA:DLN): 2.72% yield

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.