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