Dividend ETFs and the Fiscal Cliff | ETF Trends

The fiscal cliff deadline is less than a month away, and Washington is looking at higher taxes on dividends for high-income investors as a way to diminish the burgeoning deficit. Nevertheless, dividend exchange traded fund investors should not overreact to the proposed tax hikes, says an executive at a firm that manages several dividend-themed ETFs.

Jeremy Schwartz, director of research at WisdomTree Investments, notes that on Jan. 1 the preferential 15% tax rate will end and investors will have to deal with 20% capital gains and dividends taxed at ordinary income rates, reports Matt Nesto for Yahoo Finance. [Dividend ETFs: Obama Wants Dividends Taxed as Ordinary Income]

“Since the President enacted a 0.9% Medicare payroll tax, plus another 3.8% to fund Obamacare, the highest tax on dividends is set to go up to 43% under that scenario for the highest income earners,” Schwartz said in the article. [Three Reasons Not to Flee Dividend ETFs]

Nevertheless, Schwartz pointed out that there “are number of mitigating factors” that diminish the impact of the changes. Specifically, almost 50% of dividend-generating stocks are held in “tax insensitive accounts,” like IRAs, pension funds, endowments and non-profits. A sell-off in anticipation of the fiscal cliff “could motivate these investors” to pick up where others left off, Schwartz added.

Moreover, in the 50% of none tax-free accounts, only half of the holders, or 25% of overall dividend stock holders, are subject to the top tax rate.

Oddly enough, Schwartz pointed out that tax rates and market performance seem to follow an inverse relationship as we’ve experienced the lowest rate on dividends and gains in 70 years.