|
Beat the Taxman with
Yields of 28.8%
|
|
Published:
December 29, 2008
During his campaign, President-Elect
Barack Obama vowed to "reverse Bush tax cuts for the wealthy." In other
words, the tax cuts passed in 2001-2003 under George W. Bush
would be rolled back or allowed to expire on December 31, 2010.
Investors feared the reduced 15% tax rate on dividends and capital
gains enacted would revert to previous levels. That would mean
you could be taxed up to 38.6% on dividend income and up to 20%
on capital gains.
The bad news is that the income tax rates for some taxpayers
will likely increase. The good news is that dividend and capital
tax rates likely will not revert back to previous levels. But
because of these changes, it's more important than ever for
income investors to try to plan accordingly.
It's hard to plan for tax laws that may or may not pass and
could take effect in 2009 or not until 2011. But there's no
denying that taxes can have a big impact on your total returns.
For example, a Morningstar study shows that between 1926 and
2007, stocks returned an average +10.4% annually before taxes,
but only +8.2% after taxes. The tax bite was even greater for
bonds -- +5.5% annual pre-tax returns over the same period
dwindled to +3.5% after taxes.
Obama plans to raise the top two tiers of income tax rates. When
the Bush tax laws expire at the end of 2010, or sooner if the
new administration prematurely rolls back the tax cuts, the top
brackets will increase from 33% to 36%, and from 35% to 39.6%,
according to the
tax plan
that Obama laid out during his campaign.
For investors in the top tax brackets, the higher rates would be
applied to income that's taxed as ordinary income. That includes
interest income from bonds and certain preferred shares, as well
as real estate investment trust distributions.
Good News for Income Investors
The good news for income investors is that the widely
anticipated tax increases for dividend and capital gains under Obama's tax plan aren't either as broad or as steep as
originally feared. Unless the administration prematurely rolls
back the Bush tax cuts, the reduced 15% rates on dividends and
capital gains will stay in place for another two years.
Once the tax cuts expire on December 31, 2010, investors would
still enjoy reduced tax rates on dividends and capital gains.
The new administration proposes to keep the rates essentially
the same for low and middle-income investors. For households
earning over $250,000 annually, the plan will raise the federal
tax rate on long-term capital gains and dividends, but just a
smidgen, from 15% to 20%.
Here's exactly what the President-elect tells us in Barack Obama's Comprehensive Tax Plan:
Capital Gains: Families with incomes below $250,000 will
continue to pay the capital gains rates that they pay today. For
those in the top two income tax brackets -- likewise adjusted to
affect only families over $250,000 -- Obama will create a new
top capital gains rate of 20 percent.
Dividends: The top dividends rate for people making over
$250,000 would be set at 20 percent. Dividends will not return
to being taxed at ordinary income tax rates." (Italics are as
given in the plan.)
This plan is good news. If passed, it would allow investors the
freedom to choose among a wide variety of income securities
without fear that their income would be taxed away, even in a
taxable brokerage account.
Where to Find Tax-Advantaged Income
Securities that pay "qualified" dividend income would continue
holding their value, including certain preferred shares,
foreign-based American Depository Receipts (ADRs),
ordinary taxable corporations, and tax-advantaged closed-end
funds. Qualified dividend income is income that qualifies for
the reduced dividend tax rate and is not taxed at the higher
ordinary income tax rate, potentially up to 39.6%.
Of course, campaign promises can swiftly change course once the
new administration actually takes the helm. Then, too, the
president isn't solely responsible for new tax policies.
Congress will need to vote on any tax code changes, and the
ballooning federal deficit may force the government to alter the
tax regime in ways that may not be beneficial to income
investors. We'll continue to monitor this issue of dividend
taxation, but most analysts are not anticipating any radical
changes from Obama's stated tax plan for dividends and capital
gains.
What action should you take? If you
are in the top tax tiers, then you
may want to start planning to
protect your assets from the higher
tax rates on ordinary income.
Tax-exempt municipal bonds and bond
funds and master limited
partnerships are two asset classes
that are well worth considering for
your taxable brokerage account.
Regardless of your tax bracket, however, you should be able to
continue to benefit from the lower dividend tax rates on
qualified investments. For example, tax-advantaged funds,
specifically designed to provide qualified dividend income that
takes advantage of the reduced dividend tax rates, can help all
investors beat the taxman and maximize portfolio returns.
Now is a great time to take a look at these tax-advantaged
funds, too. Many are selling at fire-sale prices due to tax-loss
selling that ratchets up during the last two months of the year.
We are wary, though, of funds that use leverage to spike
returns, as borrowing costs have become prohibitive for them in
this tight credit environment.
As such,
High-Yield Investing editor
Carla Pasternak carefully
hand-picked ten tax-advantaged
closed-end funds in the latest issue
of her newsletter. Using the
criteria below, she identified
tax-advantaged funds with yields as
high as 28.8%.
delivers mostly tax-advantaged income that qualifies for the
reduced tax rate
doesn't employ leverage
carries a dividend yield of better than 6%
If you'd like to learn more about
the tax-advantaged income funds that
Carla identified
and more about the
High-Yield Investing newsletter,
please visit this link.
|
|
|
|
|
| FREE
six times a week, our newsletter contains actionable investment ideas from
today's leading market analysts. |
|
|
|
|
The Next 433 Banks That Could Fail
There are 7,932 banks in the United
States -- and 433 are in immediate danger of failing.
If you have cash in any of
these banks your savings could be at
risk.
|
|
|
|
|
