With ETFs, Cap Gains and Divs Are Paid Together?

[Mo Money]

I recently asked my online broker, Schwab, to pay dividends in cash, rather than reinvest them, to provide some funds for some living expenses now that I am ER'ed. The Schwab rep I had on the phone arranged this, and asked whether I wanted capital gain distributions paid in cash also. I said no. He replied that for my mutual funds, that could be done, but that for my ETFs, I had to elect to get paid in cash on neither, or both, dividends and cap gains. I sheepishly said "Okay, pay both in cash then, rather than reinvest them."

Question 1: Can anyone explain why ETFs don't allow you to make separate payment elections on dividends and cap gains? Or is this some Schwab quirk?

Question 2: Is it folly to have cap gains paid out in cash along with dividends, or wiser to reinvest the cap gains instead?

 

[utrecht]

Maybe I'm misunderstanding something, but ETF's don't pay capital gains.

 

[Mo Money]

Well, if that's the case, then maybe I misunderstood, and told him to elect to pay the dividends (the only option available) in cash.

Hey others out there: Can you chime in and confirm that Utrecht got it right, and I, Mo Money, should put on the dunce cap and cower in the corner for a while? (I am tempting a response from REWahoo with that one...)

 

[Sunset]

Since you need the money, I'll assume you are in the 15% marginal tax rate group.
Therefore its smart to take Div and Capital gains as cash since they will be tax free.

You don't say which ETF's , so I wonder if Schwab is tricking you for some extra fees.
Do the ETF's throw off capital gains naturally (seems odd) or will these be generated by Schwab selling some of your ETF to generate the capital gain ?

I have a bunch of ETF's and I cannot recall seeing any capital gain payment on them, lots of dividends paid out.

You better call that Schwab guy back.

 

[MichaelB]

It's not that simple. Most index equity ETFs don't have capital gains to distribute because favorable tax regulations allow them to be "traded away". Some do, however - here are iShares 2014 ETF capital gains iShares Capital Gains Distributions

An ETF might have distributable gains for a number of reasons, including a change in the index or insufficient trading activity. It's probably safer to say most of the time, most equity ETFs shouldn't be expected to incur and distribute capital gains.

 

[Rosie]

Not sure if the OP was referring to stock ETFs exclusively, but, I was just looking at the ETFs offered by Vanguard, and their bond ETFs do distribute cap gains.

 

[rbmrtn]

ETFs generally don't have CGD because they don't have a lot of trading turnover vs MFs; but they can. I think schwab treats them like a stock in that dividends can be reinvested.

Why Are ETFs So Tax Efficient? | ETF.com

Also you can change the reinvestment option from your account positions page without calling them.

 

[Cobra9777]

Question 1: Can anyone explain why ETFs don't allow you to make separate payment elections on dividends and cap gains? Or is this some Schwab quirk?

I don't know why, but I can confirm that Fidelity has exact same options. So, likely not a Schwab quirk. But as others have said, because ETFs rarely pay CG distributions, the lack of separate choices has minimal, if any, consequence. And, that's probably the reason.

Question 2: Is it folly to have cap gains paid out in cash along with dividends, or wiser to reinvest the cap gains instead?

I only own ETFs, so I don't deal with this. For your mutual funds, I don't think it's "folly" to take the CG distribution in cash, especially if you have high year-end cash needs, like property tax, charitable contributions, rebalancing, or IRA funding. Others take dividends in cash and reinvest CGs, mainly to keep smooth cash flow, although there may be other reasons I don't recall.

 

[MooreBonds]

I don't know why, but I can confirm that Fidelity has exact same options. So, likely not a Schwab quirk. But as others have said, because ETFs rarely pay CG distributions, the lack of separate choices has minimal, if any, consequence. And, that's probably the reason.

Just conjecture on my part - but I think it has more to do with the legal entity nature of an ETF vs a mutual fund. Perhaps something related to the ETF transfer agent not segregating it out, vs a mutual fund company taking it on their own to do the math and calculation of what is capital gain vs what is dividend when they send it to the broker? Same reason why a REIT stock wouldn't have an option for you to reinvest what is legally a "capital gain" vs what is legally a "dividend", and is instead (initially) considered 100% 'dividends' (until your broker gets the final distribution figured out at the end of the year).