Avoiding Taxable Dividends with ETF

If you want to invest in exchange traded funds, but do not want to increase your tax burden, avoid investing in any ETF that pays dividends. Although many investors choose to invest in ETFs over mutual funds in order to bypass some tax issues, ETFs have tax issues of their own. You will receive a taxable dividend distribution when an ETF makes money from the dividend of an underlying stock. These distributions are considered taxable income to shareholders, even if you bought the ETF too late to really profit from the dividends. The addition of a dividend might undesirably drive you up a tax bracket, making the extra income nothing more than a burden.

You should avoid buying ETFs before the yearend distribution of dividends, or avoid buying ETFS that pay out dividends altogether. Instead, you will probably want to invest in ETFs that hold stocks for capital appreciation. If you review the underlying investments of the ETF carefully enough, you can avoid dividend-paying ETFs.

Look At the Name Of The ETF

You can sometimes tell if the ETF produces high dividends by looking at the name of the stock.  If the ETF has “High Yield” or “High Dividend” in its name, it probably produces dividends that you do not want.

Avoid ETFs that Hold Bonds

You should also avoid bond ETFs. Bonds often pay out guaranteed interest or distribution payments. These dividend-like payments become part of the ETF’s income, and are often distributed to shareholders in the form of dividends.

Research the History of the ETF

Do your research before buying any ETFs. Research online at Yahoo, Morningstar or any number of other services. Find out if the fund has produced a lot of dividends in the past. Look at the past prices of the ETF to find out the amount of these dividends.

Buy Growth Stocks and Avoid Value Stocks

Value stocks are more likely to pay dividends than growth stocks. This is because growth companies are more likely to reinvest any profits they might have earned in order to grow the company, instead of paying out dividends to its tax holders. If you want to avoid paying taxes on dividends, get an ETF that holds mostly growth stocks under it.

Stocks in Certain Industries Are More Likely To Pay Dividends

You should understand what industry sectors the ETF is invested in. For example, tech stocks have not traditionally paid much in dividends. Bank, real estate, and oil sector stocks tend to pay relatively high dividends.

Examine the Investing Strategy of the ETF

Avoid investing in any ETFs that maintain an aggressive buy and sell strategy. When ETFs sell an underlying asset to create income, it automatically produces dividends. If you want to avoid paying taxes on dividends, invest in ETFs with buy and hold strategies.

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