Are Your Dividends Safe in 2013?
Dividend stocks have been a favorite way to generate low-tax income. However, if capital gains taxes rise from 15 to 20 percent for an important segment of the shareholder community, will companies reduce dividends in favor of equity appreciation?
At the moment, the Dow 30 stocks have an average dividend yield of 3.04 percent, with the highest AT&T (NYSE:T) yielding 5.34 percent and the lowest Bank of America (NYSE:BAC) yielding 0.69 percent. If you are a retiree with $1,000,000 invested across the Dow 30, you receive $30,400 a year in income minus 15 percent capital gains tax for a total of $25,840 in income.
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Of course, this hypothetical retiree is not likely making over $400,000. Thus, he/she would not be subject to the higher capital gains rate of 20 percent. But is that reason for celebration? NO.
Here’s Why the Fiscal Cliff Compromise May Not Protect You
Large companies take actions based on the political will of significant shareholders. These include institutional investors and the extremely wealthy. Unlike the average retiree living off fixed-income such as dividends, large shareholders are likely making greater than $400,000 or $450,000 a year. Moreover, many of them don’t necessarily need the extra cash from all their dividends. Consequently, most will prefer to play games to defer or reduce their tax burdens in the event of a tax hike.
One such game will be…
lobbying companies to reduce dividend payouts in favor of reinvesting the cash back into the business. In theory, this allows the value of the underlying asset to rise (increasing a personal balance sheet) without paying taxes on cash distributions.
Recently, even tech titan Apple (NASDAQ:AAPL) got into the dividend game. The company currently pays a ~2 percent dividend to loyal shareholders. However, the ROI on that cash could be much higher if Apple can reinvest that money into the core business and inflate the current stock price. Strong companies such as Apple have a very real cost-benefit calculation to make in this situation, especially if large shareholders start complaining and lobbying.
On the other hand, some companies may not have a way to leverage as much growth as Apple. For example, a utility company like Duke Energy (NYSE:DUK) pays a 4.9 percent dividend yet may conclude that’s the best use of their cash despite changes in tax rates. Moreover, a company like Duke Energy likely has a large constituency of both retirees and institutions who have invested specifically for the yield. Therefore, an dividend policy changes would require an uphill battle when compared to Apple.
So, are your dividends safe in 2013? Depends on the underlying company. However, if you consider the examples of Apple and Duke above, you’ll have a good model for making an educated guess about the safety of your dividends this year.
Don’t Miss: Apple’s 4 New Patents to Kick Off 2013.