Switching from accumulating to income ETF

Hey community members!

I recently downloaded the freetrade app and I plan to invest in a small portfolio of Stock ETF’s. One thing I have come to understand is that the same ETF can come in various iterations. The basic variation is either accumulating (dividends are automatically reinvested) or distributed (dividends are payed out to investors and they can choose to reinvest or do whatever they wish with the money).

I’d like to invest over a long period of time and eventually be able to earn passive income off dividends. I’ve noticed that the accumulating ETF’s (usually) perform better than the distributing ones over the same time periods, and all the advice I have read suggests that if I’m going to hold onto the ETF’s for a long time I should go for the accumulating type to allow them to grow to full potential.

Furthermore I understand it’s best that I open a stocks and shares ISA so that I can shield my investments from taxation especially considering I’m going for long term investments (which eventually would be subject to large capital gains tax upon selling).

I think a good approach for me to take based on what I’ve mentioned would be to go for accumulating stocks and to keep investing in them on a monthly basis for a long period of time and then switch to the distributed version when I’d like/require the passive income from dividends. My problem is that this would require me to sell all of the ETF’s in order to perform the switch. If this was the case I would only be able to purchase £20K (or whatever the limit is at that point in time) of the investments into the ISA and the rest would then need to be put into a normal account which is susceptible to taxation (in particular the dividends).

One solution I see is that by pre-empting this I can just go ahead and buy the dividend paying ETF’s right now an reinvest the dividends as I’m going along to simulate an accumulating ETF, but I also read that this would be sub optimal.

Is there anything else I have missed here, is there any other solution to this problem?

Thanks for taking the time to read this!

The £20k annual limit on ISA contributions is for adding cash into the account. When it’s in there, HMRC don’t care what you do with it. So, you could sell all of your accumulating ETFs and rebuy the distributing versions no matter how much the total value is.

The accumulating funds are performing better because the dividends are re-invested by the fund manager and used to buy more shares. So, in theory the value should be the same regardless of type.

Most people seem to think that accumulating is better as you then sell the shares as and when you need the money, but personally, I don’t think there’s much in it. Outside an ISA, dividends are taxed as income rather than capital gains, which may be beneficial for you, or may be worse for you.

Accumulating performs better because it includes compounding of the dividends. They both have the same returns if you plan to manually reinvest dividends from distributing ETF.

If you are investing in an ISA (no difference in tax treatment) and reinvesting all dividends in the same ETF then it is still good to invest in a accumulating ETF because it is less hassle. But in my opinion, distributing ETFs are better because they give me the choice to invest dividends in someting else that I think might be better value.

As already mentioned, £20k is simply the annual limit to deposit in an ISA. You can buy and sell any amount of ETFs in the future with the funds you have in your ISA.

@Jubatus Thanks for the information regarding ISA limit’s, that’s really helpful.

@ralf @DavidM That’s interesting, so it seems there would be no real difference if I went with the distributed vs accumulating ETFS’.