John D. Rockefeller, the 19th century oil magnate, once said
“Do you know the only thing that gives me pleasure? It’s to see
my dividends coming in.”
John D. Rockefeller, the 19th century oil magnate, once said “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
Not coincidentally, Rockefeller was reportedly the richest man in the world when he retired.
Due to 2003 tax-law changes, which dropped the maximum tax rate on qualified dividends to 15 percent, dividends appear to be returning to the forefront of investor interest.
Two decades ago, dividends were far more popular: 469 companies in the S&P 500 paid dividends on their common stock in 1980.
Today there are about 360 S&P 500 companies making the payouts.
Over the course of history, dividends have played a major role in total portfolio appreciation. Between 1926 and 2003, dividend distributions accounted for 42 percent of the S&P 500 total return.
That means nearly half of the S&P 500’s 10 percent average annual return was dependent upon dividends.
The new tax rate on qualified dividends took effect in 2003. Under previous tax law, dividends were taxed at ordinary income tax rates.
If the current law is allowed to expire, dividends will again be taxed as ordinary income in 2009.
Does this mean that you should shift your portfolio to dividend-paying stocks?
As usual, it depends upon your personal situation, but the favorable tax treatment is an important factor to consider.
The new tax treatment of dividends has created an incentive for investors to own dividend-paying companies outside of tax-deferred accounts.
Dividends paid on stocks owned within an employer-sponsored retirement plan or a traditional IRA will be taxed as ordinary income when they are withdrawn in retirement.
Individuals who want to take advantage of the new tax law may want to consider holding dividend-paying stocks in taxable accounts because today’s dividend tax rate is almost certain to be lower than tomorrow’s income tax rates.
Even though dividends are more tangible than earnings, they still have their critics. Here are two common complaints. Cash paid out to shareholders depletes corporate wealth.
By giving money to shareholders, the corporation may be saying that it does not believe reinvesting in the company is a better use of its cash.
As corporations are slowly emerging from a recession, many may need all their cash to make some important capital expenditures that were postponed during uncertain times. Yet there is increasing pressure to pay dividends.
Some experts have pointed out that corporate cash belongs to shareholders whether it is paid out as dividends or reinvested to increase the company’s asset value.
The more that is handed out in cash, the less can be expected in the form of capital appreciation.
Cash dividends create a taxable event. When a company declares a dividend, shareholders must pay taxes based on the company’s timing rather than their own.
Even investors who want to reinvest their dividends must pay taxes on them first.
Of course, some investors own companies that pay dividends precisely because they want income.
But some investors who don’t want the immediate tax liability prefer to own companies that tend to pay stock dividends, as opposed to cash dividends, because there is no taxable event until shares are sold.
This allows investors to defer taxes for as long as they desire. The new tax law has changed how investors — and companies — view dividends.
Dan Newquist is a Registered Representative with Linsco/Private Ledger (Member SIPC). His office is in downtown Morgan Hill.
