ETF.com Analysis

Beyond Special Dividends, Payout ETFs Loom

November 30, 2012
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Many investors are getting a special dividend treat in late 2012, and while that's exciting, it’s all about a changing tax picture.

And that means some investors are going to be faced with choices.

We generally hew to a buy, hold and rebalance sensibility here at IndexUniverse, so I’m not going to say that all these special dividends suggest the end is near or that dividend-focused ETFs ought to be avoided but, please, do be cautious and aware.

After all, tax issues are thorny, and should be taken seriously and thoughtfully—with professional advice.

As it stands, dividends are taxed at a rate of 15 percent, but if the U.S. were to lurch off the so-called "fiscal cliff" at the end of the year, the tax rate on those dividends could jump to as much as 40 percent.

One thing seems clear: Companies are looking to throw investors a bone by distributing many extra payouts either in the form of "special dividends" that were not previously scheduled or by shifting 2013 dividends into end-of-year 2012.

A total of 173 companies have announced special payouts this month—a 140 percent jump from November 2011—according to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.

To take a step back, I think dividends are already unduly punished by the tax man, and it could get worse very soon.

As a shareholder in a company, you are a partial owner, and in turn you own a share of the earnings that the company produces. The company is taxed on those earnings, and if they choose to return your earnings to you—the owner of those earnings—they are taxed again. Good for Uncle Sam; bad for investors.

For investors who depend on dividends for cash flow, that tax risk is material and, as I was saying, they really ought to speak with a tax professional to formulate a new coping strategy.

The rest of us, I suppose, can enjoy the treat! The extra dividends or early payouts are an unexpected consequence of our dysfunctional Congress.

Don’t forget though, there’s no such thing as a free lunch: Unless the economic recovery gains some serious traction, dividend yields in general will almost certainly start shrinking in 2013. Just don’t be surprised when it happens.

There is, however, some hope for dividend yields in 2013.

 

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