GETTING PERSONAL: Div Tax Cut Is No Bone For Retirement
08 Jan 15:48
By Kaja Whitehouse
A Dow Jones Newswires Column
NEW YORK (Dow Jones)--Plans to make dividends tax-free to individual
investors will not help investors where they need it most, and in fact, it may
hurt them.
That's because a good chunk of individual investor assets are locked away in
tax-sheltered retirement plans, like the 401(k) and the IRA. These plans are
already exempt from paying taxes on dividends, so making them tax-free changes
nothing.
In fact, the plan could hurt American's nest eggs if the price of dividend
paying stocks rise due to the new tax-free aspect, because then investors would
be paying a premium for a benefit that they don't receive.
The same holds true for pension funds, which tend to avoid tax-free
investments because, as tax-exempt organizations, they don't get the benefit.
"It's like tax-exempt bonds; it would be malpractice for a pension fund manager
to invest in municipals (bonds)," said Martin Sullivan, an economist at Tax
Analysts in Arlington, VA.
Under the current system, a person with an IRA, for example, can expect to
pay income taxes on dividend income, or the distribution of a company's
earnings to shareholders, when he or she withdraws funds from the account. If
dividends were made tax-free, nothing would change for the typical IRA owner,
except perhaps the price of dividend paying stocks, which might inflate on the
benefit of their tax-free income.
Opponents of this thinking say that dividend yielding stocks cannot be
compared to municipal bonds because the dividend portion of the stock is
miniscule. "The dividend payout ratio is so small, I don't see it being a major
factor," said Karl L. Polen, member of the board of directors of the Arizona
State Retirement System in Phoenix.
A rise in stock prices will benefit investors, not hurt them, said John
Scarborough, a principal at Bingham, Osborn & Scarborough, a San Francisco
retirement planning firm. "I think retirement savings will benefit if this
proposal goes through, because it will mean a boost for stocks."
But the reason to avoid dividend yielding stocks in tax-sheltered plans goes
back to a basic investing principal that says people should take advantage of
any tax-sheltered status with more heavily taxed instruments, and keep lower
tax investments in taxable accounts, said Alan Auerbach, professor of economics
at the University of California, Berkeley.
For some, this has meant even stocks are an unwise choice for tax-sheltered
vehicles because they are otherwise taxed at the lower capital gains rate.
People have continued to invest stocks in tax-sheltered retirement plans on the
argument that they have greater growth potential than many high tax investments
like taxable bonds, said Auerbach.
But dividend paying stocks tend to grow at a slower pace than stocks that
reinvest the money into the company. If these stocks were maintained in a
taxable account, the investor could theoretically avoid all taxes if there were
no dramatic rise in the stock price. But in a tax-deferred 401(k), for example,
he would still shell out income taxes.
Bush's plan "pushes (the debate) more in the direction of taking equities out
of 401(k)s, IRAs and other tax-sheltered vehicles," said Auerbach.
That would be a dramatic shift from current investing habits. In 2001,
individual investors put 64% of their stock and hybrid mutual fund assets into
tax-deferred accounts, according to data from the Investment Company Institute,
a membership association for the mutual fund industry in Washington, DC. When
you add in bond funds, the number drops to one-third of mutual fund assets in
tax-deferred instruments, said ICI.
Approval of the Bush tax cut could dramatically change the profile of the
typical dividend stock investor, said Sullivan, the economist at Tax Analyst.
The clientele of investors who will buy them now should behigher tax-bracket
individuals instead of tax-exempt pension plans and investors who invest
primarily in retirement plans, he said.
Younger people still might find it worthwhile to put some dividend yielding
stocks in their retirement accounts because they have more time to see the
stock prices rise, making the tax bite more worthwhile, said Jacob Friedman,
chair of tax department at law firm Proskauer Rose. But older people, who are
perceived as being in greater need of punching up their retirement savings,
will want to avoid these instruments, he said.
"You put that money into a 401(k)," he said, "and it converts it, presto, a
tax-free dividend into a taxable dividend."
-By Kaja Whitehouse, Dow Jones Newswires, 201-938-2243,
kaja.whitehouse@dowjones.com
(END) Dow Jones Newswires
01-08-03 1548ET |
