Seven Hidden Downsides of Dividend Investing, From a Financial Adviser

Dividend investing has long been pitched as a safe, reliable way to generate income, especially in retirement.

But after years of conversations with clients and families, I've found that dividend strategies are often misunderstood and, in many cases, can create more problems than they solve — especially when it comes to taxes.

Here's the hard truth: High-dividend investing is not a magic formula. When you peel back the layers, it can actually increase your tax burden, limit flexibility and stunt long-term financial growth.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The Kiplinger Building Wealth program handpicks financial advisers and business owners from around the world to share retirement, estate planning and tax strategies to preserve and grow your wealth. These experts, who never pay for inclusion on the site, include professional wealth managers, fiduciary financial planners, CPAs and lawyers. Most of them have certifications including CFP®, ChFC®, IAR, AIF®, CDFA® and more, and their stellar records can be checked through the SEC or FINRA.

Let's break down seven common problems with dividend investing — and explore a few smarter, tax-savvy strategies that can help you stay in control in retirement.

What is dividend investing?

Dividend investing involves purchasing stocks that regularly pay a portion of their earnings to shareholders. These payments can feel like "free money," and for retirees, it might seem like the perfect setup: regular income without touching your principal.

That perception is often flawed. Let's look at why.

Problem No. 1: Dividend income can lead to unexpected tax bills

In a taxable account, dividends equal taxable income. Period. Whether you re-invest or cash them out, Uncle Sam wants his cut.

• Qualified dividends. Taxed at capital gains rates (0%, 15% or 20%).
• Nonqualified dividends, often from real estate investment trusts (REITs), master limited partnerships (MLPs) or bond funds, are taxed at ordinary income tax rates up to 37%.

For high-income retirees or those with other income sources, such as required minimum distributions (RMDs), those tax bills can add up fast.

For example, if you earn $20,000 in qualified dividends, you'll face a $3,000 tax bill at the 15% rate, even if you don't require the income.

Problem No. 2: Dividend payments take away your control over taxes

Dividends are mandatory taxable events. You don't control when they're paid or taxed.

In retirement, where income planning is essential — whether you're timing Roth conversions, managing income-related monthly adjustment amount (IRMAA) brackets or strategically drawing from accounts — dividend income can complicate things and reduce flexibility.

Compare that with capital gains: With a total-return strategy, you decide when to realize income. That's power. That's planning.

Problem No. 3: The truth about dividend payments and wealth redistribution

Many people think dividends are a "bonus." In reality, they're just a reshuffling of value.

When a company pays a dividend, its share price drops by that amount. You're not gaining wealth — you're just moving it from one pocket to another (and paying taxes in the process).

Wouldn't you rather control that cash flow — and when it's taxed — yourself?

Problem No. 4: Don't mistake dividend stocks for safe investments

Some investors think dividend stocks are a safe, bond-like replacement. But dividend stocks are still stocks — and they carry equity market risk.

During the COVID-19 crash, bonds dropped about 5%. Dividend stock ETFs dropped 25% or more. The 2008 crash told a similar story.

If you're taking a stock-level risk, why not aim for total return and long-term growth instead?

Problem No. 5: High dividend payouts can stunt innovation and returns

Companies that pay high dividends are often mature, with fewer reinvestment opportunities. That can mean slower growth, less innovation and potentially lower returns.

Looking for expert tips to grow and preserve your wealth? Sign up for Building Wealth, our free, twice-weekly newsletter.

As investors, we want our money in places where it can grow — not just generate short-term payouts. Dividend-heavy strategies can rob you of long-term upside.

Problem No. 6: Hidden cost of ignoring non-dividend stocks

Focusing only on dividend-paying stocks cuts out a massive portion of the market — especially smaller, innovative and high-growth companies.

In 2022, more than 60% of U.S.-listed companies didn't pay dividends. Some of the best long-term performers fall into that category.

Problem No. 7: Risk of relying on dividends for retirement income

Companies can cut dividends at any time.

Think GM (2009), BP (Deepwater Horizon) or even Disney (2020). If your retirement income depends on these payouts, sudden cuts can be disruptive — or devastating.

What can retirees do instead?

Let's talk tax-savvy giving: QCDs and DAFs.

If your goal is income, tax efficiency and making a difference with your wealth, there are smarter ways to go about it — especially once you hit retirement age.

Qualified charitable distributions (QCDs). QCDs allow IRA owners age 70½ and older to give up to $100,000 per year directly from an IRA to a qualified charity. The donation counts toward your RMD, but it does not count as taxable income.

Benefits:

• Avoid taxes on up to $100,000 of IRA distributions
• Reduce your adjusted gross income (AGI), which can lower taxes on Social Security and Medicare premiums
• Fulfill charitable goals and shrink future RMDs

It's one of the most powerful tools for retirees with charitable intent.

Donor-advised funds (DAFs). A DAF is like a charitable investment account. You make a financial contribution (and get a tax deduction now), but you can give the money to charities later, on your own timeline.

Why use one?

• Make multiple donations in a high-income year for a bigger deduction
• Contribute appreciated assets (such as stock) and avoid capital gains
• Continue giving year after year from one place, while growing the funds tax-free

For retirees experiencing windfalls, large RMDs or selling appreciated investments, DAFs offer a way to offset taxes, support causes and stay strategic.

The better alternative: Total return plus smart planning

Rather than chasing dividends, consider a total return strategy that focuses on growing your portfolio and taking income when it's most tax-efficient.

Pair that with ...

• QCDs to lower IRA taxes
• DAFs to bunch deductions
• Capital gains timing for flexibility
• Roth conversions during low-income years

... and you've got a flexible, tax-savvy and retirement-optimized financial plan.

Final thought

Dividend investing might feel familiar and comfortable — but when you look deeper, it often creates tax headaches, reduces diversification and limits your options.

Instead, focus on growth, flexibility and thoughtful planning — using such tools as QCDs and DAFs to shape your retirement story the way you want it told.

Let me leave you with this: Are you building your retirement income plan on outdated strategies — or one that puts you in control of your future, your taxes and your giving?

This article has been updated.

Insurance products are offered through the insurance business Thatcher Wealth Management. Thatcher Wealth Management is also an Investment Advisory practice that offers products and services through AE Wealth Management, LLC (AEWM), a Registered Investment Adviser. AEWM does not offer insurance products. The insurance products offered by Thatcher Wealth Management are not subject to Investment Advisor requirements.

Please remember that converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA.

Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Any references to protection, safety, or lifetime income, generally refer to fixed insurance products, never securities or investments. Insurance guarantees are backed by the financial strength and claims paying abilities of the issuing carrier.

This article is intended for informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual's situation.

Thatcher Wealth Management is not permitted to offer and no statement made during this show shall constitute tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. The information and opinions contained herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Thatcher Wealth Management. 3136574 - 07/25

Related Content

• Dividend Investing: Pros, Cons and Rules to Follow
• Stocks With the Highest Dividend Yields in the S&P 500
• Diversification: An Investment Adviser's Guide to Why You Need It and How to Achieve It
• Running Out of Money in Retirement: Nine Steps to Help Reduce the Risk
• Retirement Is a Journey: Do You Have the Map?