Dusko Stojkov's  Instablog

Dusko Stojkov
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A DC based transactional and tax attorney, financial planner, and a stock market investor, formerly a principal front office capital markets products and loan syndication structurer with a regional European full service bank. Now a tax partner with Perry, Krumsiek & Jack, LLP, a Boston based law... More
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Washington International Business Counsel LLP
  • Tax considerations on shifting investments into higher yielding stocks 0 comments
    Mar 22, 2010 9:32 PM | about stocks: DVY, PEY, HYG, JNK, LQD, VYM, VIG

    If you are an investor realigning your after-tax investment portfolio from a low yielding growth indexed ETF or a mutual fund, into a higher yield corporate or bond ETF or mutual fund, seeking higher returns, before making changes to your investment strategy you need to carefully consider tax implications. Generally, realigning your portfolio form a low yielding growth ETF or a mutual fund into a high yield equity ETF or mutual fund is tax advantageous over shifting investments into a corporate bond or government bond ETF or mutual fund. 

    As a general rule, individuals pay Federal income taxes at a lower rate on qualified dividends (most dividends from a domestic corporation and some dividends from a foreign corporation) than they pay on other types of investment income such as interest and royalties. Tax rates on qualified dividends are set at a rate of 15%, for individuals otherwise in a 25% or higher tax bracket, and at a rate of 5% (0% for tax years beginning after 2007 and before 2011) for individuals in 15% or lower tax bracket. 

    However, since investors receive (on a Form 1099) ETF or mutual fund distributions retaining the character of the underlying fund income, an investor in a 25% or higher tax bracket investing in a high yield stock fund would pay taxes on fund distributions at a rate of 15%, while the same individual investing in a corporate bond fund would pay taxed on dividends from the bond fund at a rate of 25% per year. 

    If primary reasons for realigning your portfolio are to reduce risk to your portfolio, there probably will be slightly more risk to principal from investing in a high yielding stock fund than from investing in a bond fund. However, you may be willing to take additional principal risk, since your investment in a high income stock fund may also appreciate more than your investment in a bond fund. If you believe that we are nearing an interest rate rising period, both corporate and government bond yields are likely to rise and high yielding stock and bond funds are likely to decrease in value.
    Before switching from one investment to another, tax-factors should be considered. Shifting investment from one investment fund to another may involve tax costs. However, with proper planning, these costs can be kept to a minimum. 

    The contents of this post may not be relied upon to avoid penalties under the Internal Revenue Code. 

    Disclosure: No positions

    Disclosure: No positions
    Stocks: DVY, PEY, HYG, JNK, LQD, VYM, VIG
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