Millions of investors have made
big bets on dividend stocks
lately, turning to their higher-yield income streams as an
alternative to thoroughly inadequate payouts from other income
investments. By doing so, they've been willing to take on the
risk of investing in stocks versus less volatile instruments,
some of which guarantee principal repayment.
But an even bigger risk looms large at the end of this year:
the expiration of the low tax rates on dividends. If those
provisions expire -- and it's increasingly looking like a
dysfunctional government will allow them to -- could it spell the
end of the three-year bull market?
The end of an era -- maybe
For more than a decade, taxpayers have enjoyed lower tax rates on
their income. But the tax cuts of the early 2000s came with a
, and in this case, the midnight clock-chimes are set to come on
Dec. 31, 2012.
At that point, several things will happen. Higher income tax
brackets will apply to
kinds of income and at all levels, as the special 10% bracket
will disappear and the top tax rate will rise to 39.6% from its
current 35%. Capital gains taxes will jump from 15% to 20%, and
the estate tax will apply to many more families as the wealth
threshold falls back to around $1 million.
But one of the biggest hits will come for dividend investors.
Come 2013, dividends will get taxed at full ordinary rates --
meaning that some high-income taxpayers will see their taxes jump
from 15% to nearly 40%.
Much ado about nothing?
A couple of years ago
, when this issue first came up, I noted that despite concerns
that a tax increase could hit the stock market hard, there were
many reasons to think it wouldn't. That time, the government
kicked the can down the road with a two-year extension of the tax
cuts. It's entirely possible that the same thing will happen this
But there's an even better reason to stay confident about
stocks this time around. In the past, when tax rates have risen,
the stock market hasn't been affected. In fact, research from a
strategist discovered that returns were actually
in tax-hike years than in tax-cut years.
Focusing on dividend stocks
Moreover, when you drill down on dividend stocks, you have to
consider several factors:
- Many popular dividend stocks
don't get a favorable tax rate. Mortgage REITs
have their dividends taxed at full ordinary
because of the source of the income they generate, so a small
increase in overall marginal rates won't have a big impact on
- Many investors already shelter dividend stocks within
tax-favored accounts like IRAs. Since they're not worried about
taxes, they aren't likely to change their strategies.
- Perhaps most important, many of the most reliable dividend
stocks are in industries that have historically held up well
even in overall stock-market downturns.
Procter & Gamble
Johnson & Johnson
) , and
) all have around half a century of annual dividend increases
under their belts. While products like Tide detergent,
Band-Aids, and cola drinks aren't entirely recession-proof,
these companies aren't the sort of high-growth up-and-comers
that tend to crash and burn in big stock-market declines.
When you put all these things together, it's easy to conclude
that if anything, dividend stocks are
insulated from a potential tax-rate hike than many of their less
So if you're afraid that Washington gridlock will jeopardize your
portfolio, you can stop worrying, at least on this score. And
whether an aging bull market eventually ends in the face of
higher taxes or not, select high-quality dividend stocks will
still be a good way for investors to ride out the storm.
Which dividend stocks are the best, then? Let me invite you to
read more about dividend stocks in the Motley Fool special report
"Secure Your Future With 9 Rock-Solid Dividend Stocks." A free
copy can be yours today, in which you'll discover everything you
need to know about these nine generous dividend payers.
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