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.”

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