Accumulating vs distributing ETFs

As with many investment funds, some exchange traded funds (ETFs) generate income. However, different ETFs treat this income in different ways. Some pay the income directly to investors as cash, in the form of dividends or interest. Others automatically reinvest the income into the ETF’s underlying investments. Here’s what you need to know about accumulating vs distributing ETFs.

What is the difference between accumulating ETFs and distributing ETFs?

Both types of ETF may earn investors income, in the form of dividends or interest, with one key difference.

• Accumulating ETFs automatically reinvest the income back into the ETF, boosting the value of your ETF both directly and through compounding.
• Distributing ETFs pay out the income directly to investors. You can choose what to do with the money.

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How does a distributing ETF work?

The income you earn, in the form of dividends from shares or interest from bonds, is paid directly to you.

The income will be paid at regular intervals – typically quarterly or half-yearly – either directly into a linked bank account or, in some cases, as a cheque. The amount of income will depend on how much money you have invested and how well the companies held within your ETF have performed.

You could manually reinvest this income in the ETF, invest or save it elsewhere, or use it to top up your other sources of income, from a salary or pension, for example. If you choose to reinvest it, you may incur trading fees that you may not have incurred had you opted for an accumulating ETF.

How does an accumulating ETF work?

As highlighted above, with accumulating ETFs any dividends or interest are used to buy more assets in the ETF on your behalf. This can result in the value of your ETF growing without you having to reinvest. Not only do you benefit from the direct increase of the amount of the dividend or interest, but it will also mean you benefit from the effect of compounding. This is where future earnings are based on a higher baseline value, boosting the future income that your ETF can earn (and reinvest).

You can find out more about compounding in our full guide to dividend ETFs.

Do I pay tax on ETF dividends?

Potentially, yes. Unless you hold your ETF within the tax-efficient wrapper of a stocks and shares ISA or a personal pension, investment dividends may be liable for tax. The tax you may pay is known, unsurprisingly, as dividend tax. It applies whether or not the dividends are paid out. This means that even if your dividends are reinvested within an accumulating ETF, they are still subject to dividend tax.

The amount of dividend tax you pay depends on your income tax band. However, dividends are taxed at lower rates than income from wages and pensions. Basic-rate taxpayers, for example, pay dividend tax of 8.75%. And, in the 2023-24 tax year, you have a dividend tax-free allowance of £1,000 per year before you have to pay dividend tax at all. From April 2024, this allowance goes down to £500.

How often do distribution ETFs pay dividends?

The frequency of ETF dividend payments can vary. There are no official rules dictating how often dividends should be paid. Quarterly or half-yearly is the most common, but you may also find ETFs that pay dividends annually or, occasionally, monthly.

How often do accumulation ETFs reinvest?

Whether an ETF is accumulating or distributing doesn’t in and of itself affect how often dividends (or interest, where applicable) are paid. Just as the frequency of direct dividend payments can vary with a distribution ETF, so can the frequency of reinvestment of dividends or interest for accumulation ETFs. This would typically be quarterly or half-yearly, but could also be monthly, annually, or at another interval.

Pros and cons of accumulating ETFs

Pros and cons of distributing ETFs

Bottom line

Distributing ETFs pay out any dividends or interest earned directly to investors, whereas accumulating ETFs automatically reinvest any income into the underlying assets. Both have advantages and disadvantages, and the right type for you will depend on your circumstances and investment goals. Use the information in this guide to help decide which type is best for you or, if in doubt, speak to a professional financial adviser.

Frequently asked questions

• How can I tell if an ETF is accumulating or distributing?

  Often, the difference will be clear from the name. Accumulating ETFs often have ACC at the end of the name, while distributing ETFs will have DIST at the end. If they don’t, or you want to be absolutely certain, read the ETF Key Investor Information Document (KIID), which should contain all the information you need to know about an ETF.

• Whats the difference between an ETF and an index fund?

  Both ETFs (exchange traded funds) and index funds are collections of assets. Index funds will always track a stock market index, such as the FTSE 100. Some ETFs do the same, though you may also find ETFs that operate slightly differently and may include non-stock assets, such as bonds.

  Both of them will offer you good diversification and low costs. The key difference is that the 2 types of fund are traded slightly differently. ETFs are traded on stock exchanges, so their prices are “live”. Index funds are bought from the fund manager (via a broker, adviser or investment platform), and shares within them are priced daily based on their current net asset value.