How Do Dividends Work in Exchange Traded Funds or ETFs? | Canstar (2024)

FAQs

How Do Dividends Work in Exchange Traded Funds or ETFs? | Canstar? ›

ETFs pay dividends earned from the underlying stocks held in the ETF. An ETF that receives dividends must pay them to investors in cash or additional shares of the ETF.

An ETF owns and manages a portfolio of assets. If those assets pay dividends or interest, the ETF distributes those payments to the ETF shareholders. Those distributions can take the form of reinvestments or cash. ETFs that position themselves as dividend funds generally opt for cash distributions over reinvestments.

And one of the world's most popular index funds, the Vanguard S&P 500 ETF (VOO), happens to pay a dividend. However, some income-focused investors may prefer to focus on other funds that pay more than the VOO dividend.

Cons. No guarantee of future dividends. Stock price declines may offset yield. Dividends are taxed in the year they are distributed to shareholders.

Most funds reinvest all dividends and capital gains earned by their portfolios. These reinvested earnings are taxed at your individual tax rate. However, when you elect to redeem your units after seven or more years and receive your distribution, you pay tax only when you sell any of the shares you receive.

ETFs pay dividends earned from the underlying stocks held in the ETF. An ETF that receives dividends must pay them to investors in cash or additional shares of the ETF. Dividends may be taxed at the long-term capital gains rate or the investor's ordinary income tax rate.

Dividends and interest payments from ETFs are taxed like income from the underlying stocks or bonds they hold. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. 18 If you profit by selling shares in an ETF, that is taxed, like when you sell stocks or bonds.

While it is possible to live off ETF dividends, you'll need to do some careful planning to make it happen. You'll need to balance how much income your investments bring in and how much you spend.

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

How long do you have to hold an ETF to get a dividend? ›

Types of dividends

These dividends are paid on stock held by the ETF, which must own them for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Dividend reinvestment can be done manually, by purchasing additional shares with the cash received from dividend payments, or automatically through dividend reinvestment plans. Automatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs.

There are numerous fees and expenses associated with an exchange fund, including but not limited to those associated with advisory, distribution, shareholder servicing, redemption, selling commissions, interest, and borrowing costs. Tax risks.

To receive a distribution, you must own the ETF, that is the trade must have fully settled, before the record date. This means that you should aim to buy an ETF at least two business days before the record date (as ETF trades take two business days to settle) should you wish to receive a distribution.

There are ETFs that pay dividends monthly, such as the JPMorgan Equity Premium Income ETF (JEPI) and the Global X Nasdaq 100 Covered Call ETF (QYLD). However, these don't necessarily invest exclusively in monthly dividend stocks — instead, they sell covered calls on stocks and use them to pay monthly dividends.