Some mutual funds have the word “dividend” in their name, indicating that they invest in the stocks of companies that pay above-average dividends or increasing dividends. While the stocks in the S&P 500 now have an average yield under 2 percent, some dividend-oriented funds yield 3 percent, 4 percent, or more.
When these dividends are passed through to fund investors, the top tax rate is usually 15 percent In addition, the rate is only 5 percent for investors in the bottom two tax brackets.
In 2006, married couples with taxable income up to $61,300 will pay only 5 percent on stock dividends, including those passed through by mutual funds. Many retired couples will be in that income group so dividend-paying stock funds can be a good source of tax-advantaged cash flow.
Even better, in 2008 most dividends will be exempt from federal income tax, for taxpayers in the bottom two brackets. In that year, holding dividend-paying stocks and stock funds will be a prime tax shelter.