An exchange-traded fund (ETF) includes a basket of securities and trades on an exchange. If the stocks owned by the fund pay dividends, the money is passed along to the investor. Most ETFs pay these dividends quarterly on a pro-rata basis, where payments are based on the number of shares the investor owns.
Key Takeaways
- 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.
Allocating Dividends
If an ETF has 100 shares of a company outstanding, the investor who owns ten shares has the right to 10% of the dividends earned by the ETF. The financial institution managing the ETF will receive the distribution and pass it to investors, usually quarterly.
If five stocks in the ETF pay quarterly dividends of $1 each and the fund owns ten shares of each of the stocks, the fund earns $50 in dividends per quarter. The investor who owns 10% of the shares of the ETF earns a quarterly dividend payment of $5.
The first ETF introduced in 1993 was the SPDR S&P 500 ETF (SPY), which tracks theS&P 500 Index.
Types of Dividends
There are two types of dividends that an ETF can pay to investors: qualified dividends and non-qualified dividends. The tax consequences for the two are different. Most investors will pay a lower rate on capital gains than on ordinary income. As of 2023, the capital gains tax was 0%, 15%, or 20% depending on income. The earned income tax rates range up to 37%.
- Qualified dividends: The ETF designates if the dividends distributed are qualified. The dividends are then taxed at the capital gains rate based on an investor's modified adjusted gross income (MAGI) and the taxable income rate that ranges from 0% to 20% in 2023, as determined by the Internal Revenue Service (IRS). An investor only earns the ETF-qualified dividend if they own the shares for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
- Non-qualified dividends: Non-qualified dividends are the remaining ETF dividends equal to the total dividends minus any dividends treated as qualified dividends. These dividends are taxed at the investor's ordinary income tax rate and are commonly paid on stocks held by the ETF for 60 days or less.
8,800
The number of ETFs available to investors globally in 2023.
How Are ETF Dividends Paid to Investors?
ETF dividends maybe paid to investors in the form of a cash distribution or a reinvestment in additionalshares of the ETF.
How Do Individuals Invest in ETFs?
ETFs can be purchased or sold on a stock exchange in the same way as individual stocks. An ETF contains a basket of securities and is commonly structured to follow an index or industry sector, such as commodities, technology, or biotechnology.
How Do Investors Determine What Dividends Are Paid by an ETF?
Investors can research the dividend yield for the ETF, which is expressed as a percentage. The yield reveals how much a company pays out individendseach year relative to its stock price. Some ETFs focus on high-dividend investments. Two ETFs that focus on dividends 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 dividends for at least ten consecutive years.
The Bottom Line
Exchange-traded funds are similar to stocks in that they can be bought and sold throughout the trading day. An investor who wants to reap the benefits of dividends can choose an ETF that focuses on dividend-paying stocks. Dividends can be distributed as cash or reinvested in the ETF.
Correction—Dec. 1, 2022: This article was edited to update the definitions of both qualified and unqualified dividends that may be paid to investors in an Exchange Traded Fund (ETF).
FAQs
Well, if the underlying companies that an ETF holds pay dividends, these are paid directly into the fund. The ETF collates all forms of income within the fund and pays this out to the investor as part of a regular distribution.
How does an ETF pay dividends? ›
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.
How long do you have to own an ETF to get a dividend? ›
Moreover, the investor must own the shares in the ETF paying the dividend for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. This means if you actively trade ETFs, you probably can't meet this holding requirement.
What is the dividend rule for ETFs? ›
The amount an investor gets in dividends is dependent on how many shares of the ETF they own – for example, if 1,000 shares of an ETF are available and a single investor owns 10, then they would hold 1% of the portfolio, and thus be entitled to 1% of dividend payments.
Do ETFs pay dividends like mutual funds? ›
Mutual funds may pay capital gains distributions at the end of the year and dividends throughout the year, while ETFs may pay dividends throughout the year. But there's a difference in these payouts to investors, and ETF investors have an advantage here, too. ETFs may pay a cash dividend on a quarterly basis.
What is the best dividend ETF to buy? ›
7 Best High-Dividend ETFs to Buy Right Now
| High-Dividend ETF | Assets Under Management | Trailing Dividend Yield* |
|---|
| ProShares S&P 500 High Income ETF (ISPY) | $86.5 million | 10.5% |
| VanEck BDC Income ETF (BIZD) | $1.1 billion | 10.7% |
| Invesco Senior Loan ETF (BKLN) | $7.2 billion | 8.8% |
| SPDR Blackstone High Income ETF (HYBL) | $153 million | 8.1% |
3 more rowsMay 29, 2024
ETF Distribution Yield
To calculate distribution yield, take the total distributions over the last 12 months and divide them by the net asset value of the fund at the end of the 12-month period. Many issuers use an alternate method to calculate: multiply the most recent distribution by 12 and then divide by the NAV.
Can you live off ETF dividends? ›
So what does it mean to live off your dividends? If you invest in dividend-paying stocks, mutual funds, or ETFs, which provide distributions of stocks or cash to shareholders, over time, the cash generated by those dividend payments can supplement your income when you retire.
Which Vanguard ETF pays the highest dividend? ›
ETFs: ETF Database Realtime Ratings
| Symbol Symbol | ETF Name ETF Name | Annual Dividend Yield % Annual Dividend Yield % |
|---|
| VIG | Vanguard Dividend Appreciation ETF | 1.78% |
| VYM | Vanguard High Dividend Yield Index ETF | 2.87% |
| VYMI | Vanguard International High Dividend Yield ETF | 4.78% |
| VIGI | Vanguard International Dividend Appreciation ETF | 2.01% |
2 more rowsAutomatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs although most brokerages will allow you to set up a DRIP for any ETF that pays dividends. This can be a smart idea because there's often a longer settlement time required by ETFs.
Cons. No guarantee of future dividends. Stock price declines may offset yield. Dividends are taxed in the year they are distributed to shareholders.
What is the tax loophole of an ETF? ›
Thanks to the tax treatment of in-kind redemptions, ETFs typically record no gains at all. That means the tax hit from winning stock bets is postponed until the investor sells the ETF, a perk holders of mutual funds, hedge funds and individual brokerage accounts don't typically enjoy.
What are three disadvantages to owning an ETF over a mutual fund? ›
Disadvantages of ETFs
- Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
- Operating expenses. ...
- Low trading volume. ...
- Tracking errors. ...
- The possibility of less diversification. ...
- Hidden risks. ...
- Lack of liquidity. ...
- Capital gains distributions.
As with stocks and many mutual funds, most ETFs pay their dividends quarterly—once every three months. However, ETFs that offer monthly dividend returns are also available.
Do S&P 500 ETFs pay dividends? ›
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.
