Are ETFs required to pay out a percentage of income as dividends?

By Investopedia Staff AAA
A:

The exchange-traded fund (ETF) is a relatively new investment vehicle, hitting the market in 1993. A fund company can create ETFs when it is awarded specific exemptions from the Investment Company Act of 1940, a law enforced by the Securities and Exchange Commission (SEC) that governs companies offering investment funds to the public. Typically, a fund company must be awared three exemptions from the Investment Company Act of 1940 before the prospective ETFs are allowed to be sold on the market. These exemptions relieve ETFs of the following:

  • the requirement for funds to be individually redeemable
  • the requirement that funds cannot be traded at a negotiated price
  • the disallowance of funds to be traded as in-kind transactions

Some ETF issuers have requested exemption from other rules that usually apply to mutual funds. Up to this date (2005), no ETF issuers have been awarded the request for exemption from the requirement to pay out dividends collected from securities held in their funds. Some ETFs, however, have been granted permission by the SEC to reinvest the proceeds from dividends in ETF holders' accounts. (Costs of running an ETF are subtracted from dividends to be paid to ETF holders at least annually.) Dividends received or reinvested are taxed as personal income to the ETF unit holders. In the case of ETFs that realize a capital gain, the gain is passed onto the holders of the ETF funds, and also taxed as personal income.

So, as of 2005, the SEC has not granted any exemptions to laws that require distribution of income on a fund's holdings. However, an investment company can deduct its expenses for running the ETF from distributions it receives on its holdings. That is, the investment company can deduct its business costs of running the ETF from the money it generates on the ETF's funds.

Though there aren't any ETFs that are exempt from the requirement to make distribution payments to the fund's shareholders at least annually, ETFs are still developing. As securities laws are constantly changing, it is possible that future ETFs may be exempt from distribution requirements.

For more information on ETFs check out our An Inside Look At ETF Construction.

RELATED FAQS

  1. What does a mutual fund's beta coefficient measure?

    Evaluate the risk associated with a particular mutual fund by determining its beta coefficient, which illustrates the fund's ...
  2. What is the difference between the dividend yield and the dividend payout ratio?

    Learn the differences between a stock's dividend yield and its dividend payout ratio, and learn why the latter might be a ...
  3. What metrics should I evaluate when looking for high-yielding dividend stocks?

    Evaluate high-yield dividend stocks to determine if they are a good investment to produce steady income. Learn what questions ...
  4. What's the safest way to invest in high-yielding dividend stocks?

    Learn about some of the most important safety factors that you need to consider before you invest in high-yielding dividend ...
RELATED TERMS
  1. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  2. Paid-Up Additional Insurance

    Additional whole life insurance that a policyholder purchases ...
  3. Licensed For Reinsurance Only

    A license that allows a company to engage in services related ...
  4. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  5. Plant Patent

    An intellectual property right that protects a new and unique ...
  6. Patent Agent

    A professional licensed by the United States Patent and Trademark ...
Related Articles
  1. Economics

    Indian Banking Regulations -- What You ...

  2. The iShares FTSE China 25 Index Fund etf has become popular with investors seeking China exposure. Here's why.
    Stock Analysis

    This ETF Offers Easy Access To China's ...

  3. Africa's economic growth and growing stability has gotten the attention of adventurous investors. What kind of ETF or mutual fund options are available?
    Mutual Funds & ETFs

    Destination Africa: These Funds Offer ...

  4. With its huge population and booming economy, China is tops for many emerging markets investors. Here's a leveraged ETF for those who want to double down.
    Stock Analysis

    This Leveraged ETF Is For China Bulls

  5. These ETFs are an excellent place to start for any investor interested in betting on Latin America.
    Mutual Funds & ETFs

    Interested In Latin America? Eye These ...

Trading Center