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Dividends offer attractive return, but tax question remains

Updated: May 3, 2013 12:15PM



Q. I was thinking about buying some dividend paying stocks, or a mutual fund that invests in them, so I could
earn more than I’m getting in interest on my savings. But now I hear that the tax rate on dividends will go up. Should I buy those stocks?

A. That’s a good question. A lot of investors have been buying stocks to get dividend yields of 3 percent or more. That looks very attractive compared to 6-month CDs or Treasury bills, which currently pay around 0.1 percent!

But even stocks that pay dividends are no substitute for “chicken money,” which belongs in the bank. Stocks can always fall in price, and dividends could be cut in the future. There are no guarantees. Still, we’re becoming more aware that money in the bank is a sure “loser” as the value of your savings is eaten away by inflation, running at nearly 3 percent. You can thank the Fed for that. And they’ve just promised to keep rates low.

That search for yield is one of the reasons the stock market remains near its highs. Over the long run, dividends have contributed more than 40 percent of the total return of the S&P 500. You learn everything you need to know about dividend investing at Chuck Carlson’s website: BigSafeDividends.com.

But you’re right to be concerned about possible future increases in tax rates on dividends and capital gains. If the “Bush Tax Cuts” are allowed by Congress to expire at the end of this year, it will mean not only an increase in individual tax rates, but a huge percentage increase in the tax rates on dividends and gains.

If the current tax law expires, the tax on dividends will rise from the current 15
percent maximum to as high as 43.4 percent. And the capital gains tax rate
will rise from 15 percent to a maximum of 23.8 percent.

And remember, these dividends are taxed twice — once when the corporations earn the money to pay the dividends, and a second time when you report the income on your tax return! Combined, the tax rate on dividends is already over 50 percent.

While some people think that only the rich pay these taxes anyway, that is far from the truth. A dividend tax increase would hit seniors and retirees particularly hard. According to the IRS, taxpayers age 50 and older file almost two-thirds of all tax returns that show dividend income. And those over age 65 file close to a third of those returns.

It’s a classic case of political demagoguery to imagine that only “rich people” collect dividends.

And if this tax increase is allowed to happen, it will certainly impact prices of dividend-paying stocks to some extent — although investors are well aware of the possibility and have priced some of that uncertainty into the stock market already.

Still there’s a movement afoot to get Congress’ attention to the potential impact. Go to

DefendMyDividend.org

to learn more about the impact of rising tax rates on dividend income — and how to send a message to our elected officials.

We all feel less wealthy when the stock market goes down. And taxing the returns from investing is hardly the way to build confidence in the market — or in America. That’s the Savage Truth.

Terry Savage is a registered investment adviser.



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