Investors who have rushed into dividend ETFs the past two years in search of income need to be mindful that taxes on dividends are scheduled to rise next year if the Bush-era tax cuts are allowed to expire.
However, the chance that investors may end up forking over more dividend income to Uncle Sam doesn’t necessarily mean they should run out and dump their dividend-themed ETFs, which have been hot sellers in a low-interest-rate market for bonds.
“The appeal of dividends is not now–and has never been–purely a function of tax policy. Dividends work because they deliver what capital gains can’t: consistent cash returns that are always and only positive,” says Josh Peters, editor of Morningstar’s Dividend Investor newsletter.
“Rather than depending on fickle and often panicky markets for returns, dividends provide cash flow that you can use to meet your personal investment objectives even if stock prices are down,” he writes. “And, compared with bonds, dividend-paying stocks offer a measure of protection from inflation and a good shot at lasting capital appreciation.”
In other words, taxes are part of the return equation but investors need to take a broad view on dividend ETFs.
President Barack Obama’s re-election and the looming fiscal cliff have many predicting that the tax breaks on stock dividends and capital gains won’t be renewed at the end of 2012. If the tax cuts expire, the rate on qualified dividends could rise from 15% to as high as 39.6% for top earners. [Dividend ETFs: What Obama Win Means for Tax Rates]
Dividend ETFs vulnerable?