Tax Cost vs. Deferral
Last week, we wrote about the importance of tax efficiency. Portfolios that minimize capital gains distributions help increase investors’ after-tax expected returns and enable them to delay realizing those gains until liquidating at a time of their choosing. But this is a deferral. In most cases, those taxes will be paid when the fund shares are sold. On the other hand, minimizing income tax costs can actually save investors money.
Qualified dividends carry a much lower tax rate than nonqualified, which typically get taxed at an investor’s marginal income rate. Equity strategies that maximize the amount of qualified income potentially increase an investor’s after-tax return. And that’s a tax savings, not a deferral, because you are taxed at the lower capital gains rate rather than the ordinary income rate.
It’s important for investors to recognize that the ETF wrapper, selected by some investors pursuing greater tax efficiency, doesn’t impact qualified dividend income (QDI) percentage. That depends on implementation. In the US, it’s possible to reach 100% if the strategy excludes REITs1 and has flexibility in holding periods. Neither is generally the case for index funds, and the top three US index fund ETFs have averaged 93% qualified over the past five years.
Outside the US, the max QDI percentage tends to be lower because of countries where the US lacks tax treaties. For example, these countries account for about 3% of non-US developed markets,2 which means it is possible to have over 90% percent of dividend income qualified for a developed market strategy. For emerging markets strategies, it is possible to have over 50% of the dividend income qualified. We see that the largest non-US index fund ETFs are well below these potential QDI percentages.
Average Percent of Dividend Income That Is Qualified
Largest three market index fund ETFs by region for the five-year period ending December 31, 2025
Past performance is not a guarantee of future results.
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Footnotes
- 1. Dividend income from real estate investment trusts is generally nonqualified, and these securities also have high dividend yields.
- 2. Based on market capitalization weights of countries in the MSCI World ex USA IMI Index as of June 30, 2026. Market capitalization weight of countries in the MSCI Emerging Markets IMI Index where the US lacks tax treaties was approximately 37% as of June 30, 2026.
Glossary
Capital gains: Money that may be distributed to shareholders when a fund sells a security for a profit.
Dividend income: A distribution of earnings that companies may choose to pay shareholders.
Dividends, qualified and nonqualified: Qualified dividend income is taxed at lower capital gains tax rates, while nonqualified income is taxed at higher ordinary income rates.
Real estate investment trusts (REITs): Securities that provide investors a focused exposure to the income from real property assets. REITs must hold most of their assets in real estate, derive most of their revenue from real estate related sources, and distribute nearly all of their earnings to shareholders.
Disclosures
All expressions of opinion are subject to change. This information is not meant to constitute investment advice, a recommendation of any securities product or investment strategy (including account type), or an offer of any services or products for sale, nor is it intended to provide a sufficient basis on which to make an investment decision. Investors should consult with a financial professional regarding their individual circumstances before making investment decisions. Diversification neither assures a profit nor guarantees against loss in a declining market.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
This article is offered only for general informational purposes, does not constitute investment, tax, or legal advice, and should not be relied on as such. Please consult with qualified legal or tax professionals regarding your individual circumstances.
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