Income or accumulation: which option is right for you?
So, you’ve decided which funds you want to invest in. But you’ve got another choice to make: which type of share class? Don’t be put off; it’s really quite straightforward.
Most shares and bonds1 typically pay their investors an income. In the case of bonds, it’s usually a fixed rate of interest, which is why bonds are also known as ‘fixed income’.
Shares can also pay an income in the form of dividends2. However, companies aren’t obliged to pay them and sometimes reduce or cut them, so it’s less dependable income.
Some investors may find it interesting that funds (including exchange-traded funds, or ETFs3) come in different forms – or ‘share classes’. But it’s not that different from choosing a brand and model of a car and then deciding whether you want an estate or saloon version.
There are two principal types of share class – ‘income’ (also known as ‘distributing’) and ‘accumulation’ – and they both do what they say on the tin. Income share classes pay income to their investors, while accumulation share classes let that income build up (or accumulate) in the fund.
In summary, income share classes are better suited to investors looking for an income, while accumulation share classes are designed for investors seeking to grow their capital.
What happens to the income?
Funds are constantly processing streams of income on behalf of their investors.
In an accumulation share class, the income is simply reinvested by the fund in more shares and/or bonds, to ensure it tracks the index as closely as possible.
This also happens with income share classes, but the difference is that some of the portfolio holdings will then be sold in order to fund distributions (or income payments) to the investor.
The amount of time from when a fund receives income and when it must pay out distributions to fund holders might be days, weeks or even months, but markets will move in the interim. By reinvesting the income until it is time to pay out, the fund ensures it tracks its index as closely as possible. Read more about index funds.
If you rely on income, it’s important to remember that the amount of income paid out by income share classes may fluctuate.
How are they taxed?
Returns from both income and accumulation share incur tax, unless they are held inside a tax-efficient vehicle (if eligible), such as an Individual Savings Account (ISA) or a pension, where they do not incur tax on either income from interest or dividends or on capital gains.
For UK funds (and non-UK funds with UK reporting fund status) held outside an ISA or pension:
- You may incur tax on the income derived from interest or dividends. When you sell, you may be subject to capital gains tax (CGT) on any profits you make.
- Accumulation shares do not pay out a regular income but are nevertheless taxed on the ‘accumulated income' at your regular income tax rate. The income needs to be disclosed on your tax return. Any capital growth is also subject to CGT.
- For both income and accumulation share classes, the tax rate applied to income depends on whether the income is treated as interest income or dividend income.
Vanguard General Account holders can check what information is needed to include on a UK tax return on the General Account tax information page. This page also includes information on the UK reporting fund status and how it applies to Vanguard Irish funds.
The inner workings of different share classes may be complex, but the question for investors is simple: are you looking for a regular income or do you wish to grow your capital? The choice is yours.
1 Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.
2 Dividends are the payments some companies make to their shareholders out of their profits.
3 A type of investment fund that holds potentially hundreds, sometimes thousands, of individual shares or bonds. Learn more about ETFs.
Investment risk information
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Important information
Vanguard only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.
This is designed for use by, and is directed only at persons resident in the UK.
The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.
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