How Are ETF Dividends Taxed?

Learn to navigate the complexities of ETF dividend taxation in this segment of etf.com’s Dividend Content Series.

kent
|
Research Lead
Reviewed by: etf.com Staff
,
Edited by: James Rubin

One of the primary advantages of investing in ETFs is the potential for receiving dividends, but understanding how ETF dividends are taxed before making investment decisions is important. 

Learning the complexities of ETF dividend taxation, such as qualified vs. non-qualified dividend tax rates, can help to maximize tax efficiency and optimize your returns.  

ETFs and Dividend Tax Rates  

How ETF dividends are taxed depends primarily on the types of dividends that the fund distributes. ETFs can distribute dividends in two forms: qualified and nonqualified. More specifically, the tax treatment of an ETF's dividend depends on the underlying securities that the fund holds and the length of time the investor held the ETF.  

Qualified dividends are taxed at lower capital gains tax rates, whereas non-qualified dividends are taxed at the investor's ordinary income tax rate.  

Here are the basics on qualified and nonqualified dividend tax rates: 

Qualified Dividend Tax Rate

Qualified dividends are typically paid out by ETFs that hold U.S. stocks and meet specific criteria set by the Internal Revenue Service (IRS). To qualify for lower tax rates, you must hold the ETF shares for more than 60 days during the 121-day period before the ex-dividend date. In addition, the stock must be issued by a U.S. corporation or a qualified foreign corporation.  

Qualified dividends are taxed at the long-term capital gains tax rate, which is generally lower than the ordinary income tax rate. For most investors, this rate is 15%, although it can be as low as 0% or as high as 20% depending on the investor's income level.  

Nonqualified Dividend Tax Rate

Nonqualified dividends are taxed at the investor's ordinary income tax rate up to 37%. Many taxpayers fall within the 22% or 24% tax brackets, which are higher than the capital gains tax rate. Nonqualified dividends are typically paid out by ETFs that hold securities such as real estate investment trusts (REITs), foreign stocks, or bonds.  

If an investor sells their ETF shares before holding them for at least 61 days, any dividends received will be considered nonqualified and subject to the ordinary income tax rate. Additionally, if an ETF fails to meet the IRS' criteria for qualified dividends, any dividends paid will also be considered nonqualified.  

List of Top High Dividend ETFs by AUM 

TickerFundAUMExpense RatioYield
SCHDSchwab U.S. Dividend Equity ETF$53.0B0.06%3.53%
VYMVanguard High Dividend Yield ETF$51.6B0.06%3.04%
SDYSPDR S&P Dividend ETF$20.3B0.35%2.61%
DVYiShares Select Dividend ETF$18.1B0.38%4.02%
FVDFirst Trust Value Line Dividend Index Fund$10.3B0.65%2.26%

Data for top high dividend yield ETFs as measured by assets under management Feb. 12, 2024. 

Tip: See our list of best dividend ETFs for 2024

ETF Dividend Tax When Held in a Retirement Account

Investors should remember that ETF dividends are not taxed while held in a retirement account, such as an individual retirement account (IRA) or a 401(k). This is because investments held in a qualified retirement account grow tax deferred. Depending on the contribution type, withdrawals from retirement accounts may be taxed as income.  

For example, money in a traditional IRA grows tax-deferred, which means that any interest, dividends or capital gains earned within the account are not taxed until the money is withdrawn. When the investor withdraws money from their traditional IRA in retirement, the withdrawals are subject to income tax at the investor's ordinary income tax rate.  

However, the money in a Roth IRA grows tax-free, which means that any interest, dividends or capital gains earned within the account are not taxed, and qualified withdrawals are also tax-free. To make qualified withdrawals from a Roth IRA, the account must be open for at least five years, and the investor must be at least 59 ½ years old or meet other criteria, such as a disability or a first-time home purchase.  

Certain nonqualified withdrawals from a traditional IRA or Roth IRA, such as those made before age 59 ½, may be subject to income tax and a 10% early withdrawal penalty.  

Bottom Line ETF Dividend Tax Rates

In summary, ETF dividends are taxed differently depending on whether they are qualified or nonqualified. Qualified dividends are subject to lower capital gains tax rates, while nonqualified dividends are subject to the investor's ordinary income tax rate. Before buying shares of dividend ETFs, investors should consider the tax implications, which can have a significant impact on their portfolio’s overall return.

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.