We are still here. The Mayan calendar ended December 21, 2012 but fortunately we didn’t. The fiscal cliff hung over into the wee hours on New Year’s Eve but was averted so taxpayers making less than $400k are breathing a sigh of relief that their income taxes aren’t going up — only the payroll taxes are going back to 6.2% (an increase of 2%). This is certainly good news for most Americans but it gets better. Dividends and capital gains tax rates were also saved from the fiscal cliff – they stayed the same for most Americans.
This helps all of us. Americans whose taxable incomes are over $400k ($450k if married filing jointly) are only seeing an increase in the capital gains tax rate from 15% to 20% instead of the 35% it was set to hit. A taxpayer (married filing jointly) whose taxable income is around $100K would have paid a 25% tax on dividends in 2013 but now will pay only 15%. Taxpayers who are in the 15% bracket or lower continue to have no taxes on capital gains. Their rate is zero!
Now that we have been given this gift of lower taxes, how can we maximize our good fortune? Many Americans are between a rock and a hard place right now when it comes to investing. Interest rates are low – a $100,000 investment only yields about $500 a year at the current rate of ½%. The thought of putting money under the mattress doesn’t seem so far-fetched these days.
That’s where dividend-paying stocks come in. Dividends offer a way to earn income that’s often higher than the interest you would be able to collect with that money and usually grows over time. With the new tax law, dividends will be taxed less than interest income too.
With dividends maintaining special tax treatment, here are some investments where you can benefit:
Individual dividend paying stocks. The largest five hundred companies in the US make up the S&P 500 and about four hundred of those companies pay dividends. Do a little research to find the ones that are most suitable for you that pay a healthy dividend. Here are a couple of resources:
Income funds. If you want instant diversification, consider investing in income funds or equity income funds since they are structured to pay dividends. The average dividend yield of the S&P 500 is currently over 2% which is four times what you can get in your money market account. With the expertise of a mutual fund’s money manager, you may be able to do better than that. Here are some resources to get you started:
Exchange Traded Funds. To participate in dividends in funds that are traded on the stock exchange, look for income or equity-income ETFs. The advantages are that they can be sold during trading hours, unlike a mutual fund which has to have end of day pricing on the holdings, and expenses are often less on exchange traded funds.
Resource – WSJ guide to exchange traded funds
Index funds. Instead of trying to beat the market, index fund investors want to simply match the returns of the index (minus expenses). The most commonly known index is the S&P 500 but there are many different indexes in Morningstar’s database. There are specific index funds (and exchange traded funds also) for investors who want high dividends.
Many people invest with a focus on dividends inside their retirement accounts also but with this extension of lower dividend and long term capital gains tax rates, another tool for wealth building is at our disposal. These days we need all the help we can get.