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Mutual Fund Dividends: What To Expect

Updated: Mar. 17, 2022By: Richard Best

Mutual funds receive dividends on the stocks held in their portfolios and pass them on to investors. Some funds invest specifically for dividends to produce regular income for their shareholders. Learn about how fund dividends are distributed and taxed to investors.

Dividends, distribution of profits by a corporation to shareholders.

Olivier Le Moal/iStock via Getty Images

Dividend Paying Mutual Funds: Basics

Any mutual fund that receives dividends on stocks in its portfolio is required to pass those dividends on to investors. Investors will normally have the option to receive the dividends as a cash distribution or have them reinvested in the fund's shares. Either way, fund investors have the responsibility to pay taxes on all dividends, regardless of whether they received them in cash or reinvested them.

Because of the tax and administrative responsibilities of distributing dividends, mutual funds tend to fall into two groups: those who invest for long term appreciation and will select stocks for growth potential rather than dividends; and those who 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 out only once per year, while funds designed for income will pay their dividends out to shareholders every month.

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

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

How Mutual Funds Pay Dividends

Dividends on stocks held by mutual funds are paid to the fund, which then passes them to its shareholders. The fund must pay the dividends to its investors or reinvest them in more shares, but they have flexibility in when and how often during the year, they will issue dividends. Dividends are paid on a pro-rata basis and shareholders receive no interest on dividends held by the fund. Funds with a large number of stocks paying dividends will organize their payments around a monthly schedule in order to provide investors with a regular stream of monthly income.

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

Meanwhile, the primary quote page for any mutual fund includes useful information like 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 taking their dividend payments as income or having them automatically reinvested 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 Takeaway: Dividends from growth funds may only be paid once per year, while dividends from income funds are typically paid to investors monthly. Most funds allow investors the option of taking their dividend payments in cash for current income or reinvesting them to purchase additional fund shares.

Interest Payment Distributions

Mutual funds that invest in bonds or other debt securities also receive payments directly from the 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 these payments.

Tax Considerations For Mutual Fund Dividends

Dividends are taxable to investors and mutual funds pass all dividends to shareholders. Thus, mutual fund investors should expect to pay taxes every year on their share of dividend or interest income. While most dividend funds offer investors the option to have dividends reinvested in more shares rather than paid out to them, they are still responsible for paying the 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 fund's Net Asset Value per share is reduced by the amount of the dividend. For example, if a fund's value is is $20.50 per share and it pays a dividend of $0.20 per share, the share value will drop to $20.30 prior to the next trading day. To receive a payment from the fund, shareholders must be on record as owning the fund's shares on or before the record date, which is one day before the ex-dividend date.

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

For dividends to be qualified, the fund must own 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 qualified to the fund investor depends on how long the fund has held the shares of the company -- not how long the investor has held shares of the fund. Mutual funds will disclose to investors what portion of their dividend payments are qualified and what portion 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 declared, 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 income tax rates. Your fund company will report to you how your dividend distributions from them will be treated. (IRS publication 550 contains information on the taxation of investment income and dividends.)

Bottom Line

Dividends collected by mutual funds are distributed to the fund's shareholders, who can take them as cash or reinvest them in additional shares. Either way, dividend payments are taxable to the shareholder unless received in a tax-qualified account.

This article was written by

Richard Best profile picture
Thirty-plus years in the financial services industry as an advisor, managing director, directors of marketing and training, and currently as a consultant to the industry. Author and columnist on wealth management and investing topics.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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