The Dividend Squeeze is On for High Income Earners
The American Taxpayer Relief Act of 2012 (ATRA) signed into law on January 2, 2013, made qualified dividends a permanent part of the tax code. But some dividend investors will get hit harder than others. Let's analyze some of these changes.
While, taxes on qualified dividend income for most investors will stay at 15%, individuals in the top bracket will pay 23.8% in 2013 compared to just 15% last year. (20% plus an additional 3.8% surtax for Obamacare.) The 39.6 tax bracket applies to individuals with income over $400,000 and income over $450,000 for married couples.
Dividends are cash payments made by companies to shareholders. Dividend rates are reported as certain number of cents per share. For example, a stock or ETF with share price of $10 and a dividend of 0.25 cents, the dividend yield would be 2.5%. (0.25% divided by $10)2013 Dividend TrendsStandard & Poor's expects a dividend increase of 3.6% in 2013 for stocks within the S&P 500 (NYSEARCA:IVV). The percentage of profits repaid back to shareholders via dividends (payout ratio) is at just 36% compared to its historical average of 52%.
Some companies have already begun increasing dividends.
Ford Motor (NYSE:F) just doubled its quarterly dividend to 0.10 cents, upping the yield to 3%. There have already been four dividend increases and 18 maintains in the first week of 2013, according to Markit Dividend Research.
In 2012, S&P 500 companies paid out a record $281.5 billion in dividends.
Your ETF Dividends Broadly held dividend ETFs like the iShares DJ Select Dividend ETF (NYSEARCA:DVY), SPDR S&P Dividend ETF (NYSEARCA:SDY), and Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) have had increases in both share prices and distributions. Some of these dividend increases were because of year-end (2012) accelerated dividend payments by companies ahead of ATRA passage.
Ordinary taxable dividends are the most common equity distributions and are taxed at ordinary income tax rates. In contrast, "qualified dividends" are taxed at a lower rate. Each year, your ETF provider will report what percentage of equity dividends are ordinary versus qualified.
Dividend Demographics America's aging population has put income investing on the map. One-third of all households receiving dividends are senior households (65 and older) and nearly half of dividend income is earned by seniors, according to the Tax Foundation.
Because of higher dividend tax rates on high income earners, this segment of population should tread carefully. Adding more firepower to your dividend strategy is a must. Beyond traditional dividend income sources, selling covered call options can help boost cash flow and returns. Generally, this is much safer than rotating into higher yielding asset classes (NYSEARCA:JNK) that carry high risk and volatility (NYSEARCA:VXX).
ETFguide's Income Mix Portfolio, generated $10,422 in annual income in 2012. The portfolio is designed to generate high monthly income using covered call options. The Jan.2013 trade garnered $654 in monthly income.