How To Choose Dividend-Paying Stocks For Retirees

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As you prepare or file your 2012 tax return, you need no reminder that cash pays near-zero interest. Bond yields are little better. And secondary-market bond prices will be clobbered by eventual rate increases.

Retirees, who typically rely on investment income, feel the pinch the most.

Instead, consider dividend-paying stocks. Many yield the same or more than bonds. Plus their payouts can grow over time. And their potential price gains tend to top bonds'.

The dividend yield on the S&P 500 index is around 2% now. That's about the same as the interest yield on the 10-year Treasury.

Many S&P 500 companies pay higher dividends.3M's ( MMM ) yield is 2.4%.Intel's ( INTC ) is 4.1%.

And dividends' tax benefits can help you keep more of that cash flow. Special low rates apply to long-term capital gains and to qualified dividends. Most stock dividends paid to investors qualify for the bargain tax rates.

There's a 0% tax rate on dividends paid to low-bracket taxpayers. In 2013, that rate applies to single filers with taxable income up to $36,250. For married couples, the 0% rate goes up to $72,500.

Those numbers are for taxable income, after deductions. A retired couple might have total income of $85,000, $90,000 or more, including dividends, and still pay no tax on their dividends.

If your income is over the $36,250 or $72,500 ceilings this year, you'll probably owe 15% tax on qualified dividends. If your taxable income is over $400,000 ($450,000 on a joint return), you'll owe 20%.

Paying 15% or even 20% on dividend income is better than paying tax on bond interest, which is assessed as ordinary income at rates up to 39.6% now.

Buy-And-Hold Bias

For all of these special rates (0%, 15%, 20%), retirees with long time horizons for their investing are especially good candidates. That's because the law is structured to exclude in-and-out traders from this tax break.

To get the low dividend tax rates you must hold the underlying stock for at least 61 days out of the 121--day period that began 60 days before the ex--dividend date.

The ex-dividend date is the first date on which a stock buyer will not receive the current dividend.

Say that ABC Corp. announces it will pay a dividend to shareholders of record as of May 3, 2013. The ex-dividend date is May 1.

So a hypothetical Ann Long buys shares of ABC on April 29, to get that dividend. Long must hold those shares for at least 61 days in order for that dividend to qualify for the 0%, 15%, or 20% tax rate.

So dividend-paying stocks may offer generous yields, growth potential and tax advantages. But stocks can lose value and tend to be more volatile than bonds.

The average dividend-focused stock fund lost 9.27% in the 2000-02 bear market, Morningstar says. From late 2007 to early 2009, such funds lost 41.51%.

But dividend-paying stocks can bounce back. A $10,000 investment in dividend stock funds would have grown to nearly $22,700 in the 10 years that ended March 26, Morningstar calculates. That works out to an average annual return of 8.54%.

If Long receives $30,000 a year from Social Security, that's equivalent to interest on $1.5 million of 10-year Treasuries, yielding 2%.

Jim Wright, chief investment officer of Harvest Financial Partners, Paoli, Pa., steers his retired clients to devote 20% to 75% of their portfolios to dividend stocks. His clientele averages 35%.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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