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. [Stretching for Yield with ETFs]

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. [Where to Find Yield in ETFs]

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

For more information on dividends, visit our dividends ETFs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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