Are you an unwitting tax evader? I only ask because quite a few investors seem unaware that fund accumulation units attract income tax on dividends just as much their more transparent ‘income unit’ cousins.

  • Accumulation units are a class of share that automatically reinvests dividends or interest straight back into your ETF, or mutual fund.1
  • In contrast, income units cough up dividends directly, paying you cash like three cherries on a fruit machine.

But not physically taking delivery of your dividends is no protection from HMRC. The taxman still wants his cut.

Dividends rolled up into your accumulation units are known as a ‘notional distribution’. They are taxable in exactly the same way as income units.

In other words, you owe income tax even on ‘accumulated’ income unless:

  • Your dividend income is covered by your tax-free Dividend Allowance. Any dividend earnings above that are subject to dividend income tax, regardless of whether they’re tucked away in an ‘Acc’ fund.
  • Dividend income is also tax-free where you have spare Personal Allowance. Perhaps you’re a FIRE-ee who no longer pulls down a salary. 
  • Interest income can be sheltered by your Personal Allowance, Starting Rate for Savings and Personal Savings Allowance.
  • If your accumulating funds are held within an ISA or SIPP then they’re off the taxman’s radar.
Accumulation units are no protection from the taxman

The taxman cometh

Some investors are likely paying tax twice when it comes to their capital gains tax bill on accumulating funds.

You don’t have to pay capital gains tax on the dividends and interest that have fattened your fund.

So when you come to fathom the capital gains on your accumulation funds (and as your resultant psychic scream reverberates around the universe), make sure you deduct any reinvested income from the total gain. Otherwise you’ll be overpaying.

Record collection

Of course, you can only make those deductions if you’ve been meticulously recording the dividend distributions that dropped in to your accumulation funds over the years.

And who doesn’t do that…?

The problem is accumulation unit distributions are more stealthy than income unit payouts. You don’t get to do a little dance every time those divis turn up in your trading account.

So where can you find out about them?

  • In your broker’s statement, if you’re very lucky.
  • Trustnet keeps a good account of accumulation unit distributions. Find your fund then click the dividends tab.
  • In your fund’s annual report.
  • Using Investegate’s advanced search. Set categories to ‘dividends’. Set the timespan to ‘six months’ or whatever suits you. Search for the company name of your fund. Enjoy!

Worth the hassle?

The main advantage of accumulation funds is to skip the cost of reinvesting dividends. But this cost saving is rendered superfluous if your fund isn’t saddled with trading fees or a high regular investing minimum. Many tracker funds fall into this bracket.

On the other hand, accumulating funds mean that your income is reinvested straightaway without you having to lift a finger. That’s a godsend if you prefer the hands-off approach. 

Some people prefer to hold income units outside of a tax shelter. The dividend payouts can be used to rebalance, or to pay tax bills without you having to sell units and trigger capital gains woes if you breach your exemption allowance.

Whichever way you go, just remember that any accumulation units in your portfolio are not immune to income tax.

Start recording those dividends – just for the fun of seeing what you’re earning, if nothing else.

Take it steady,

The Accumulator

P.S. – Watch out for the excess reportable income tax snare if you own offshore funds (including ETFs) unsheltered by your ISAs or SIPPs. 

  1. I’ll just refer to funds from now on, but note this refers to ETFs, OEICs and Unit Trusts.

The post Accumulation units – the income tax loophole that never was appeared first on Monevator.

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