How are bond ETF dividends taxed?
Dividends and interest payments from ETFs are taxed similarly to income from the underlying stocks or bonds inside them. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. 2 If you earn a profit by selling an ETF, they are taxed like the underlying stocks or bonds as well.
If you sell an equity or bond ETF, any gains will be taxed based on how long you owned it and your income. For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners.
The income from taxable bond funds is generally taxed at the federal and state level at ordinary income tax rates in the year it was earned. Funds that exclusively hold U.S. Treasury bonds may be exempt from state taxes.
Bond ETFs usually pay out interest through a monthly dividend. In most cases, any capital gains are distributed through an annual dividend. For tax purposes, these dividends are treated either as income (taxed at the individual's income rate) or capital gains (taxed at a different rate based on the term held).
Not all ETF dividends are taxed the same; they are broken down into qualified and unqualified dividends. Qualified dividends are taxed between 0% and 20%. Unqualified dividends are taxed from 10% to 37%. High earners pay additional tax on dividends, but only if they make a substantial income.
Differences Between Dividend ETFs And Bond ETFs
Dividend ETFs provide stock exposure, while bond ETFs give you bond exposure. Most dividend ETFs pay dividends quarterly, while most bond ETFs pay dividends monthly. There are monthly dividend ETFs, but some of these are higher-risk REIT ETFs.
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
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.
If you reinvest dividends, you can supercharge your long-term returns because of the power of compounding. Your dividends buy more shares, which increases your dividend the next time, which lets you buy even more shares, and so on.
Bond ETFs pay dividends on a monthly basis based on the interest income earned on the bonds held in the fund's portfolio.
Is it better to buy bonds or bond ETFs?
Bond ETFs can provide better diversification — often for a lower cost — can offer higher liquidity, and can be easier to implement. However, there is a common misconception, especially during periods of rising interest rates, that individual bonds should outperform an otherwise similar bond ETF.
Key Takeaways
Most of Vanguard's ETF products pay monthly or quarterly dividends. Expense ratios are the fees investors pay for investing in a fund; the lower the better.
With generally lower expense ratios than mutual funds, bond ETFs are a cost-effective way to access the bond market. Their daily transparency and the ease of tracking an index can be particularly appealing for those who value cost efficiency and operational simplicity.
Taxation of ETF dividends
If the dividend was held less than 60 days before the dividend was issued, then the dividend income is taxed at the investor's ordinary income tax rate. This is similar to how mutual fund dividends are treated.
ETF issuers collect any dividends paid by the companies whose stocks are held in the fund, and they then pay those dividends to their shareholders. They may pay the money directly to the shareholders, or reinvest it in the fund.
| Dividend ETF | Assets under management | Expense ratio |
|---|---|---|
| Vanguard High Dividend Yield Index ETF (VYM) | $55 billion | 0.06% |
| Vanguard Real Estate ETF (VNQ) | $34 billion | 0.12% |
| iShares International Select Dividend ETF (IDV) | $4.2 billion | 0.51% |
| Global X SuperDividend ETF (SDIV) | $760 million | 0.58% |
Dividend ETFs or Dividend Stocks: Which Is Better? Dividend ETFs can be a good option for investors looking for a low-cost, diversified and reliable source of income from their investments. Dividend stocks may be a better option for investors who prefer to choose their own investments.
Bond ETFs are affected by changing interest rates, because of the impact on the bonds in their underlying portfolios. When interest rates decrease, bond prices increase, and when interest rates rise, bond prices decline.
12-month yield is calculated by adding all the interest paid over the past 12 months, then dividing it by the sum of the ETF's most recent NAV and any capital gains distributions made over the past year. As such, 12-month yield is rooted in real-world observations about an ETF's behavior.
However, unlike individual bonds, most bond ETFs don't have a maturity date. And ETFs trade on an exchange, like stocks, so you can buy or sell them at any time during the trading day.
Are bond dividends taxable?
Bonds typically pay a fixed amount of interest (usually paid twice per year). Interest from corporate bonds and U.S. Treasury bonds interest is typically taxable at the federal level. U.S. Treasuries are exempt from state and local income taxes.
For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.
For starters, because they're index funds, most ETFs have very little turnover, and thus amass far fewer capital gains than an actively managed mutual fund would. But they're also more tax efficient than index mutual funds, thanks to the magic of how new ETF shares are created and redeemed.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
