Mutual fund dividends: what to expect

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Dividend-Paying Mutual Funds: The Basics

Any mutual fund that receives dividends on the shares in its portfolio is required to pass on those dividends to investors. Investors will normally have the option to receive the dividends as a cash distribution or have them reinvested in shares of the fund. In all cases, fund investors are responsible for paying tax on all dividends, whether they received them in cash or reinvested them.

Due to the tax and administrative responsibilities associated with distributing dividends, mutual funds tend to fall into two groups: those that invest for long-term appreciation and select stocks for their growth potential rather than dividends; and those that specifically invest in dividend-paying stocks to provide income to their shareholders. Funds that only receive a few dividends on their portfolio will tend to pay them only once a year, while funds designed for income will pay their dividends to shareholders every month.

For investors who specifically want the income from dividend-paying stocks, dividend mutual funds not only offer the benefit of diversification and ongoing management, they also smooth quarterly dividend income into a stream. monthly income for shareholders. Some dividend mutual funds focus on stocks of established companies with a long history of paying dividends, while others focus on stocks of companies that are consistently increasing their dividends. A high yield dividend fund invests in higher yielding stocks that may carry higher risks. Most major mutual fund groups offer one or more dividend mutual funds.

Remember: All income, including dividends and interest received by a mutual fund from its portfolio, must be passed on to shareholders of the fund and is subject to income tax, even if it is reinvested in shares of the fund.

How Mutual Funds Pay Dividends

Dividends on shares held by mutual funds are paid to the fund, which then passes them on to its shareholders. The fund must pay the dividends to its investors or reinvest them in more stocks, but they have the flexibility to decide when and how often during the year they will issue dividends. Dividends are paid on a pro rata basis and shareholders do not receive any interest on dividends held by the fund. Funds with a large number of dividend-paying stocks will organize their payouts around a monthly schedule to provide investors with a steady stream of monthly income.

Investors can view details of a fund’s dividend payment schedule in the fund’s prospectus or by accessing fund information on investment sites like SeekingAlpha.com and entering the fund’s ticker symbol in the box. search, then clicking on the “Dividends” tab. Information listed on this page includes dividend payout frequency, dividend amount and dividend yield.

Meanwhile, the main quote page of any mutual fund includes useful information such as the fund’s expense ratio, 52-week trading range, and net assets under management. This information can be found right next to the price chart.

Shareholders often have the option of treating their dividends as income or automatically reinvesting them to purchase additional shares. Additional shares are purchased at their net asset value (NAV) at the end of the day the dividends are received. With some fund groups, investors can have their dividends reinvested in a different fund within the same fund family.

Key point to remember: Dividends from growth funds can only be paid once a year, while dividends from income funds are generally paid monthly to investors. Most funds offer investors the option of receiving their dividend payments in cash for current income or reinvesting them to purchase additional fund units.

Distributions of interest payments

Mutual funds that invest in bonds or other debt securities also receive payments directly from issuers and pass them on to shareholders. As with dividend payments, the fund can choose the frequency of interest payments to its shareholders who receive a pro rata share of those payments.

Tax Considerations for Mutual Fund Dividends

Dividends are taxable to investors, and mutual funds pass all dividends through to shareholders. Thus, mutual fund investors should expect to pay taxes each year on their share of dividend or interest income. While most dividend funds offer investors the option of reinvesting dividends in more stocks rather than paying them out, they are still responsible for paying tax on those dividends in the year they were declared. by the fund. For this reason, many investors choose to have dividend income funds in a tax-qualified retirement account, such as an IRA or 401(k) plan.

When a mutual fund distributes payments to its shareholders, the net asset value per share of the fund is reduced by the amount of the dividend. For example, if a fund’s value is $20.50 per share and it pays a dividend of $0.20 per share, the stock’s value will drop to $20.30 before the trading day. next. To receive payment from the fund, shareholders must be registered as owners of the fund’s shares on or before the record date, which is one day before the ex-dividend date.

Unless received in a tax-qualified retirement account, dividends are taxable to shareholders whether received as current income or reinvested in the fund. Dividends to shareholders can be classified as ordinary or qualified. Dividends classified as ordinary are taxed as ordinary income. Qualified dividends enjoy the same favorable tax treatment as capital gains, which are taxed at the maximum rate of 20% for high incomes and can be as low as 0% for incomes below a certain threshold.

For dividends to be eligible, the fund must hold the shares of the company paying the dividend for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. For preferred stock dividends, the holding period is 90 days. Whether mutual fund dividends are eligible for the fund investor depends on how long the fund has held the shares of the company – not how long the investor has held the shares. of the fund. Mutual funds will disclose to investors what part of their dividend payments is eligible and what part is ordinary. Shareholders can find this information on the annual Form 1099-DIV sent by the mutual fund company.

Takeaway: All mutual fund dividend payouts are taxable in the year reported, unless held in a qualified retirement account. Some of the dividends may receive more favorable capital gains tax treatment, while others will be subject to ordinary tax rates. Your fund company will tell you how your dividend distributions will be handled. (IRS Publication 550 contains information on the taxation of investment income and dividends.)

Conclusion

Dividends received by mutual funds are distributed to shareholders of the fund, who can take them in cash or reinvest them in additional shares. In either case, dividend payments are taxable to the shareholder unless received in a qualifying tax account.

Dolores W. Simon