Inc v Acc ETF investment outside tax wrapper

GeoffTF

EthicsGradient said:

GeoffTF said:

InvesterJones said:

Depends what you mean by 'better' - the tax due is the same, but inc is more straightforward.

That is incorrect. There is a nasty catch with the accumulating ETFs that is not at all obvious. Assume that you buy £100K of both the distributing and the accumulating shares. Assume that the share prices have doubled when you receive your first £2K dividend. Consider the two cases:
Distributing. The capital value falls to £198K on the XD date. You pay dividend tax on £2K, assuming that there is no ERI. You need £4K income, so you sell £2K of stock. The CGT base cost for the sale is £100K * £2K / £198K = £1.0101..K. Your capital gain is £0.989989..K.
Accumulating. After dividend reinvestment the capital value is £200K. You pay dividend tax on the ERI of £2K. You need £4K income, so you sell £4K of stock. The CGT base cost for the sale is £100K * £4K / £200K = £2K. Your capital gain is £2K.
The problem is that when a dividend is reinvested within the accumulating ETF, it joins the same Section 104 pool as previous investments in that ETF. If the pool already had a large capital gain, the reinvested dividend will also have a large capital gain. You will have to pay CGT if you sell enough shares to recover the dividend (assuming that you have already used up your allowance). (This is despite having to pay dividend tax on the same dividend.) The same problem occurs with OEICs and Unit Trusts.

But I think that, while in that year your realised capital gain for Acc shares was about £1,000 more, the gain included in your remaining holding would be about £1,000 less (since you've sold another £2k's worth, and about half of that was capital gain). So this is a problem if you're constrained in one year by capital gains, but will be able to sell in some future year within the allowance, but if you're going to end up paying the CGT sooner or later, it doesn't make a difference.

Since the OP said "the intention would be that the dividends from the Income fund would be reinvested into the fund again whenever possible", they're not really in the situation of wanting more cash out of the fund each year than the dividend. Indeed, that reinvestment would join the same Section 104 pool, just like in the Acc version.

I was responding to the claim that the tax was the same. Clearly, it is not if you decide to draw an income. The OP will pay more tax even if he later decides to withdraw only the dividends if he chooses an accumulating fund.

We will not all end up paying CGT on our entire unsheltered holdings. There is currently no CGT on death or on donations to charity, for example. Most of my money will eventually go to charity, but in the meantime I need income.