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By Jason Stipp and Christine Benz | 09-26-2012 02:00 PM

Tax Talk: What to Do With Dividend Payers

Christine Benz answers reader questions about how to handle dividend payers in light of potential 2013 tax increases.

Jason Stipp: I'm Jason Stipp for Morningstar.

We recently held a retirement readiness Q&A for Premium Members on Morningstar.com, and we answered a ton of your questions, but we couldn't get to them all.

So today we're playing catch-up with Morningstar's Christine Benz, our director of personal finance. She's going to answer some of the questions about dividends that we didn't have time for during the original Q&A.

Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: Dividends are a hot topic among our readers. We did get a lot of questions about dividends during the Q&A. We didn't get to quite all of them, but we have few here that we're going to catch-up with.

The first one has to do with the tax treatment for dividends, which may or may not be changing, which is causing quite a bit of consternation for investors--that uncertainty. And the question is, I'm invested in U.S. dividend stocks in a rollover IRA. What should I do to prepare for the potential January 2013 tax increase? Do I need to convert to a Roth IRA?

Before you answer, let's talk about what some of those proposed changes are. What's on the table?

Benz: OK. So, we're seeing a number of tax-related changes. The key one that this reader is homing in on is a change in dividend tax rates.

So, qualified dividends right now for most investors are taxed at 15%. If you're in the 10% or 15% tax bracket, you're actually paying 0% on dividends that you receive. So, that is set to change to investors' ordinary income tax rates across the board, regardless of tax bracket, starting in 2013.

But there is a lot of uncertainty whether Congress might move to actually undo those changes and let the currently low dividend tax rates continue. But that at least is what's on the table, and that's what has a lot of dividend-focused investors concerned, because they've been happily harvesting dividends in their taxable accounts. Well, that will be a big difference, if their taxed rates close to 40% versus what they're paying now.

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