Do ETFs Pay Dividends?
- Real Vision
- August 23, 2022
- 5:42 PM
Exchange-traded funds (ETFs) purchase stocks in publicly traded companies on behalf of their investors. The dividends from these stocks are then distributed among the pool of investors. Exchange-traded funds pay the full dividend amount based on the number of shares the investor owns in the ETF. They pay either qualified dividends, which are taxed at the capital gains tax rate, or non-qualified dividends, which are taxed at the federal income tax rate.
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Do ETFs Pay Dividends?
An ETF is a type of pooled investment that will purchase various stocks in publicly traded companies on behalf of a group of investors. It represents a group or pool of commodities, which can include stocks and other securities. The fund may target a particular sector or stock index, such as the S&P 500 or Dow Jones Industrial Average.
Like a mutual fund, an ETF can also be sold as a commodity like any other stock on the open market. However, the price of the fund will go up and down continuously throughout the day as it is bought and sold, unlike a mutual fund that trades once daily.
Stocks purchased through ETFs pay dividends to shareholders like any other dividend-paying stock. Any dividends collected from these stocks will then be passed on to the shareholders. Most ETFs pay dividends to shareholders quarterly, but some pay on a monthly basis.
ETFs that contain dividend-paying stocks are required to send the money to shareholders either in the form of cash or additional shares of the ETF. The money is distributed to investors on a pro-rata basis, or the number of shares the investor owns in the ETF.
Not all ETFs pay dividends, but most do. The fund will not pay dividends to shareholders if none of the securities in the basket are paying dividends.
How Do ETFs Pay Dividends?
Every investor in the ETF owns a certain percentage of the securities in the basket. When ETFs purchase dividend-paying stocks, the money is divided up among the investors based on how many shares of the ETF they own compared to the number of ETF shares outstanding.
For example, if the ETF contains ten shares of ten stocks that pay $1 in dividends on a quarterly basis, the ETF will collect $100 ($1 x 10 x 10) in dividends every three months. An investor who owns 10% of all the shares in the ETF will then collect 10% of the quarterly dividend payment, or $10.
ETFs can pay either qualified dividends or non-qualified dividends for tax purposes. Qualified dividends are subject to the capital gains tax rate, which ranges from 0% to 20%, while non-qualified capital gains are taxed like regular income, with federal income tax rates ranging from 0% to 37%. To qualify for the lower tax rate, investors must hold on to the security for longer than 60 days prior to the ex-dividend date, but the rules are slightly different for ETFs.
Timing is still a factor, but the dividends will only qualify for the lower tax rate if the fund holds on to the stock for more than a year prior to the ex-dividend date rather than for 60 days. The dividends are considered non-qualified and are subject to the federal income tax rate if the fund holds on to the stock for less than a year.
The dividends can be paid out in cash or additional shares in the ETF. Investors may choose to accept additional shares in lieu of a cash payment to increase their total ownership of the fund.
Do ETFs Pay Capital Gains?
ETFs can appreciate or depreciate in value based on the performance of the stocks in the fund. Shareholders can sell or trade their shares of the ETF for a profit like any other security. These profits count as capital gains. They will be taxed either as regular income or at the lower capital gains tax rate of 0% to 20%.
The capital gains of the ETF will be taxed at the lower rate if the investor holds on to it for more than a year prior to the ex-dividend date. The capital gains will be taxed like regular income if the investor sells it after less than a year.
Which ETFs Pay the Highest Dividends?
The ETFs that pay the highest dividends are the ones that are designed to invest in dividend-paying stocks and securities. Some funds target stocks and companies with a long history of paying dividends to shareholders, such as dividend aristocrats or dividend kings.
Some examples include the SPDR S&P Dividend ETF (SDY), which tracks the S&P High-Yield Dividend Aristocrats Index, and the Vanguard Dividend Appreciation ETF (VIG), which invests in companies that have increased their dividends for at least ten consecutive years.
Investors can research the fund in question to see which metric it uses to buy and sell securities on their behalf. Those seeking dividends can look for ETFs that focus on dividend-paying stocks and securities. However, these kinds of ETFs tend to be extremely popular among investors with a high price per share. The total value of dividends the investor receives depends on the number of shares of the ETF they own compared to the number of shares outstanding. High-dividend-paying ETFs may be highly diluted, leaving investors with a smaller percentage of the total dividends.
The Bottom Line
ETFs pay dividends just like regular dividend-paying stocks and securities. They pay the full dividend rate and distribute the total dividend amount to the investors in the pool based on how many shares each person owns. Every ETF is required to pay the dividends it receives to investors. However, investors can also choose to accept their dividends in the form of additional fund shares. The dividend earnings can be either qualified or non-qualified, depending on how long the fund holds on to the stock.