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?
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. With or without a dividend, the best ETFs offer investors a way to diversify their portfolio through a single, low-expense ratio product.
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
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 are dividends paid on ETFs? ›
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.
How do you receive dividends from ETF? ›
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.
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.
What is the downside of dividend ETF? ›
Cons. No guarantee of future dividends. Stock price declines may offset yield. Dividends are taxed in the year they are distributed to shareholders.
Do ETF pay monthly dividends? ›
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.
Do you pay taxes on ETF dividends? ›
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.
Which ETF pays the highest dividend? ›
Top 100 Highest Dividend Yield ETFs
| Symbol | Name | Dividend Yield |
|---|
| OARK | YieldMax Innovation Option Income Strategy ETF | 44.36% |
| IWMY | Defiance R2000 Enhanced Options Income ETF | 42.38% |
| QQQY | Defiance Nasdaq 100 Enhanced Options Income ETF | 40.69% |
| AMZY | YieldMax AMZN Option Income Strategy ETF | 40.09% |
93 more rowsIf you want to live off ETF dividends, you'll need to consider the money you may have from Social Security benefits, pension benefits, 401(k)s, IRAs, and any other sources of income. Then, you can start to estimate how much you'll need to fill in the gaps with ETF dividends.
Do dividends from ETFs get reinvested? ›
Automatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs. However, most brokerages will allow you to set up a DRIP for any ETF that pays dividends. Today, one way or another, this option should be available on virtually all ETFs.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
How long should you stay invested in ETF? ›
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
How to calculate ETF dividend payout? ›
You can calculate the dividend payout ratio using the following formula:
- (annual dividend payments / annual net earnings) * 100 = dividend payout ratio. ...
- (3M / 5M) * 100 = 60% ...
- year-end retained earnings – retained earnings at the start of year = net retained earnings. ...
- $10M – $5M = $5M retained earnings.
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.
What is the primary disadvantage of an ETF? ›
To sum up, ETFs offer a wide range of benefits, such as diversification, low cost, and flexibility for investors of all levels. However, like any investment, they have potential drawbacks, such as market volatility and management fees.
What is the best high dividend ETF for retirees? ›
A couple of high-yielding ETFs that could be ideal for retirees are the iShares International Select Dividend ETF (NYSEMKT: IDV) and the Pacer Global Cash Cows Dividend ETF (NYSEMKT: GCOW). These funds offer mouthwatering payouts and can give your portfolio some great diversification.
Do ETFs automatically reinvest dividends? ›
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.
Do you get dividends from S&P 500 ETF? ›
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.
How do Vanguard ETFs pay dividends? ›
Investors in mutual funds or ETFs do not actually own the shares of the companies that the funds invest in; they only own a portion of the fund. However, any shares that pay dividends, those dividends are then passed onto the investor of the mutual fund or ETF directly into their account.
