You should be careful chasing “Boomer Candy.” This is no fantasy land. Products like these may work fine in calm markets, but when panic sets in, it may be another story. And watch out for the tax hit. Laura Saunders reports on the rise of covered-call and derivative-income exchange traded funds, writing:
For example, will dividends that a covered-call fund passes through to investors be “qualified” or “nonqualified”? Under the tax code, most dividends paid by public companies are “qualified” and so are eligible for favorable tax rates of 0, 15% or 20%. This is the case even if they come to investors through a fund. (A 3.8% surtax on net investment income also applies for higher earners.)
However, trading strategies used by covered-call funds can cause the dividends they distribute to become “nonqualified.” This makes them taxable at ordinary-income rates up to 37%. So a filer with a 24% top rate would owe 24% on them instead of 15%, plus the 3.8% surtax if applicable. For a top-bracket taxpayer, the rate would be 40.8% rather than 23.8%.
Here’s how this can work in practice. At the popular Global X Nasdaq-100 Covered-Call Fund (QYLD), which has about $8 billion in assets, just 1% of distributions from 2014 to 2023 were tax-favored qualified dividends. Another 53% of the payouts, which included dividends, were taxed at higher ordinary-income rates. Overall, the yield, or income payout as a share of net asset value, for the last three years has varied from 9% to 12%, according to Rohan Reddy, Director of Research at Global X.
Independent tax analyst Robert Willens says the higher tax rates go hand-in-hand with the higher payouts because the option income is taxed at ordinary rates and the type of options trading disqualifies the dividends.
By contrast, Hamilton Reiner, portfolio manager of the giant JPMorgan Equity Premium Income Fund, with about $34 billion in assets, strives to preserve qualified dividend status. The payout ratio is lower, however.
Reiner says that in 2023, nearly one-fifth of JEPI’s 7.48% payout of $4.61 a share came from qualified dividends, while the rest was taxed at ordinary-income rates. While he shuns nonqualified dividends, the fund’s prospectus technically allows them.
Action Line: Overindulging in candy can be bad for you. When you want to talk about a healthy investment strategy, I’m here. In the meantime, click here to subscribe to my free monthly Survive & Thrive letter.
