To build a stable portfolio, more investors are looking beyond stocks to bond exchange-traded funds (ETFs). Recently, bond ETFs that pay distributions every month have grown popular. They are resilient to market volatility and provide a steady cash flow.
However, experts advise that when assessing the real rate of return, investors should carefully examine the "tax-saving benefit" tied to distribution policies.
According to the financial investment industry on the 15th, a revision to the Enforcement Decree of the Income Tax Act last year requires all funds, except domestic equity funds, to distribute interest and dividends at least once a year.
Before the revision, it was common for domestic bond ETFs not to distribute interest revenue and instead reinvest it within the fund. While this maximized the "compound interest effect" by adding interest to principal without paying taxes, controversy persisted over a "tax preference" because dividend income tax could be deferred indefinitely.
With tighter rules, asset management companies overhauled their distribution methods. Current policies are broadly split into "maximum distribution" and "optimal distribution." Maximum distribution pays out 100% of the interest income, while optimal distribution minimally pays out only about 10% of the income to manage investors' tax burdens.
Generally, ETFs that pay monthly distributions use the "maximum distribution" policy. TIGER CD Rate Plus and KODEX CD Rate Active are representative. In contrast, TIGER CD Rate Investment KIS, RISE CD Rate Active, and TIGER U.S. Dollar SOFR use an "optimal distribution" approach that shares only minimal interest once a year.
Accordingly, investors should plan their strategy with the frequency and amount of taxation in mind. Bond ETFs with monthly payouts automatically withhold taxes at each distribution date. That means taxation occurs as many as 12 times a year. Still, the maximum distribution (monthly payout) policy generates a regular monthly cash flow that can be useful as living expenses for retirees, and receiving distributions directly can secure flexibility in capital management, such as reinvesting into other promising names.
By contrast, with optimal distribution ETFs, investors can directly control the timing of taxation. Because distributions are minimized and retained within the fund, taxes are imposed only when the investor actually sells the ETF and realizes a gain. In other words, by adding even the money that would go to taxes to the principal, long-term investors can maximize compound returns.
Monthly dividend bond ETFs also benefit less from compounding. For monthly payout products, distributions are paid two business days after the ex-distribution date, so even if the investor immediately reinvests, compounding does not accrue. As a result, compounding fails to build up about 12 times a year, roughly 30 days.
An official at an asset management company said, "High-net-worth individuals tend to be cautious about higher tax rates under the comprehensive taxation of financial income. To that end, they seek to receive less interest income and dividend income, but unexpected distributions can derail their tax-saving strategy."