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Income units versus accumulation units – what difference does it make?

Investment funds of the Unit Trust and OEIC persuasion generally come in two flavours. There’s the good old-fashioned income flavour, and there’s also the self-inflating, high fat accumulation flavour.1

The difference between the two is simple, subtle and useful, but it can be as confusing as identical twins who part their hair on opposite sides.

The difference between income and accumulation units boils down to this:

  • The income class of a fund pays out dividends and other income as cash, directly into your broker or bank account, with luck shortly after the fund’s distribution date.

A welcome morale boost it is, too. If you’re in the withdrawal phase of your investment life (that is, you’re a spender!) then these income units are for you.

  • The accumulation class does not shower you with lovely money. Instead it hangs on to your dues and reinvests them directly back into the fund – buying more shares and compounding your return.

Accumulation units are dull, boring and not nearly so nice as finding a little cash in your trading account every so often. All the same, they gift you discipline without effort, and that can prove hugely uplifting in the long-term, since reinvested dividends are a major factor in total returns.

How accumulation and income units treat dividends

Accumulation units defeat the enemy within

You can reinvest dividends paid out from income units, too, but you’re always prey to the temptation to divert them into some shorter-term cause, like having fun right now.

The advantage of accumulation units is that the devil-in-you has no chance to make mischief. The income is rolled up into the runaway snowball of future wealth, and you’ll barely even miss it.

In contrast, reinvest yourself and – aside from the potential self-sabotage already mentioned – you may lose a slice of your income to trading costs:

Accumulation units side-step all that.

True, it won’t make any difference if you’re a smart passive investor who buys funds that don’t incur those kind of fees.

For example, the index funds used in Monevator’s Slow and Steady passive portfolio shouldn’t attract any upfront trading charges, and so you don’t save by using the accumulation version.

Automatically reinvesting dividends in some funds may be cheaper though, and ‘capitalising’ ETFs will also benefit from lower costs. (‘Capitalising’ is ETF-speak for accumulation units. ETFs that pay out dividends are usually termed ‘distributing’.)

By the way, if like the great Wall Street financier John D. Rockefeller you only get a thrill from seeing your dividends rolling in, you needn’t entirely miss out with accumulation funds.

You are still due the same dividends that the equivalent income unit holder enjoys. By hunting about with some online tools you can see what dividends you did actually earn – before they were rolled up into your accumulation units.

The same but different

When I try to explain accumulation units to friends (I seem to have less of those than I used to!), they often go cross-eyed the moment the price differential comes up:

  • Accumulation units cost more than income units.
  • This does not make income units more attractive than accumulation units.
  • Both classes of fund will produce identical returns in the future.

At launch, the accumulation class and income class of any given fund are identically priced. But over time, the accumulation units have retained dividends in the fund while the income units have handed them out.

The retained dividends have purchased more shares for the accumulation class of the fund and thus increased the value of every unit held. Yet when you buy into a fund, you’ll get the same bang for your buck from accumulation units as from income units.

Imagine the Monevator FTSE Human Folly index tracker fund:

  • The accumulation units are priced at £2
  • The income units are priced at £1

Let’s suppose the fund goes up 10%.2

  • The accumulation units are now worth £2.20
  • The income units are now worth £1.10

If you had spent £2 on two income units instead of one accumulation unit, your cash return would have been identical at 20p. The only real performance difference is that accumulation units will without doubt be compounding your dividends as and when they’re earned, retained, and reinvested, whereas income units leave it all up to you.

Finally, please note that contrary to popular opinion, holding accumulation units instead of income units does not enable you to sidestep income tax.

The taxman doesn’t care that the dividends you earned were automatically rolled up – the dividend income earned by your accumulation units is liable for tax, and the taxman is due his cut.

Shelter your investments in the tax-repelling shield of an ISA or pension to avoid paying income tax on your dividends, whether from accumulation units or income units.

This will protect the tax scythe from cutting down your long-term returns.

Take it steady,

The Accumulator

  1. Funds with inc in the title indicate income units while acc indicates accumulation. []
  2. Remember we are talking about the capital appreciation of the underlying holdings owned by your fund here. In contrast, a 10% gain due to income would either be paid out by an income unit or reinvested by an accumulation unit, as per the natty picture above. []

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{ 78 comments… add one }
  • 50 Planting Acorns June 7, 2016, 5:51 pm

    @Marc –
    http://monevator.com/the-slow-and-steady-passive-portfolio-update-q1-2016/

    @TA… Think the HSBC reference may have run it’s course ?

  • 51 amber tree June 7, 2016, 7:38 pm

    Super simple and effective description of accumulating vs distributing.

    One point to add might be the taxes. At least in Belgium this is a hot topic as dividends are taxed at 27 pct… Accumulating ETFs are in theory taxed when you sell them… Luckily, there is a way around.

    My index fund is in a accumulating ETFs. Next to that, I plan to have a dividend portfolio, for the motivation that comes from the cash flow. The ration will be very much tilted to accumulating. When coming closer to FIRE, I will tilt it towards DGI.

  • 52 Sharpespur June 7, 2016, 8:10 pm

    I’ve wrestled over this subject for a long time and remember reading this article a while back with relief that there is no substantial difference between the two types. In the end I have decided that I will stick to INC variety for several reasons, notably:

    a) I like the ‘feeling’ of seeing my monthly/quarterly dividends come in. yes I know they are still there in the ACC version but it just does not feel the same. It helps to keep me motivated in some way.

    b) It makes working out any income liabilities with HMRC a bit easier than the record keeping and maths needed with ACC. I cant use SIPP or ISA as I am non-resident at the moment. So pay tax on UK earnings.

    c) The dividends get reinvested every month with regular savings plan and I can in some small way help to rebalance i.e. I have the choice where my dividends get reinvested.

    d) While I am disciplined enough I would not spend dividend income it does give me the flexibility to have the income if I really need it without having to draw-down at a bad time in the market. If I found myself out of work or unable to earn money for some reason, and really needed the income its there. But emergency only.

    As you said there is no right / wrong with this one – its what works for us all I guess.

  • 53 Nigel Root June 7, 2016, 9:01 pm

    I have two objections to the accumulation units version of unit trusts:-
    1. It can be the devil’s own job to get the unit trust manager to give you a tax certificate for the income that’s accumulated – after all, you have to declare it.
    2. When you finally sell that unit trust, the capital gains calculation is:-
    The sale price less (the original cost plus all those distributions over the years). Yes, all those distributions reduce your capital gains liability. And this means that, for as long as you keep an accumulation unit trust, you must keep all the paperwork.
    So I’ve given up and buy the income versions. Furthermore, if you reach that Shangri-La of investing, rebalancing your portfolio, you can use the income to do (part of) it.
    Regards,
    Nigel

  • 54 K. June 7, 2016, 9:12 pm

    Dont forget that 5000 GBP of dividends are free of tax from this year.
    So this allows buying a fund paying divs but not interest outside ISA

  • 55 SurreyBoy June 7, 2016, 11:24 pm

    Great article – and interesting comments. I use the Acc units because they are simple and require no effort. It would be nice to see a few quid appear out of thin air, but then it needs to be reinvested, so for me simplicity (and gentle reinvestment discipline) wins the day. I can equally see the case for income units if they suit your temperament.

    I guess it links into the theme that arises here frequently – that the worst enemy of the investor is the investor themselves – and knowing ones own temperament and behaviours is key to picking what works.

  • 56 John B June 8, 2016, 7:02 am

    K. Don’t be fooled by the spin put on dividend tax. All dividends were tax free for basic rate payers, now only the first £5k is. This is a tax rise for basic rate payers, a reduction for higher rate payers. And as no tax is deducted at source, it will force anyone with dividends over £5k into completing a tax return

  • 57 The Investor June 8, 2016, 9:32 am

    @amber tree — The tax situation is different in the UK, and is referenced in the article. Readers should note the comments that you’re taxed on the income in the UK with either sort of fund, and follow the link to here: http://monevator.com/income-tax-on-accumulation-unit/

    @all — I updated this article, not The Accumulator (who is still neck deep in book writing with his Monevator hours) so the archaic HSBC reference is on me. I’ll yank it out and update the Slow and Steady link (thanks for responding to that query!)

    I’d agree that outside of tax shelters, buying Income units is going to make for a far easier life. Even if you’re not currently earning enough to require you to fill in a tax return, you might be in the future and as some commentators have said at that point the historical compounding may come back to bite you in terms of tedious/impossible calculations and paperwork. Income units keep it simpler.

    Inside tax shelters (ISA or pension) I think most passive investors still in the phase of building up their pots are best going for Accumulation funds for an easy life, provided trading such passive funds (for re-balancing) is free with their platform. The tedious paperwork risk goes away as you don’t have to report on holdings inside ISAs etc.

    If you’re looking to draw an income (say in retirement) some will favour Income units and seek to live on the yield in an ideal world, and some will take a capital return approach and stick with Accumulation units which they sell down, as we’ve debated elsewhere. 🙂

    @JohnB — It’s more nuanced than that for most people, because they won’t earn more than £5,000 in dividends outside of ISA/SIPPs.

    Higher-rate taxpayers who might last year have paid tax on dividends may pay nothing this year, if they do not receive more than £5,000 in dividends.

    That’s really the critical cut-off point in these changes (and why it’s much worse if you take an income from work via dividends, where it’s very easy to receive more than the £5,000 limit.)

    See: http://monevator.com/how-uk-dividends-are-taxed/

    All that said I’d agree one should put everything you can in ISAs or SIPPs before starting to use this £5,000 allowance as any sort of tax shelter. Who knows how long it will even last in this form? 🙁

    I also fully agree that investors with sufficient funds/investments outside of ISAs/SIPPs should defuse their Capital Gains, and probably make it a core part of their strategy. 🙂

  • 58 John B June 8, 2016, 5:59 pm

    We’ve just had a letter from M&G saying they were changing their policy as to where they took their management fee from. It was a hodge-podge, but they were standardising on taking the fee from dividends for ACC, and from capital from INC. This makes sense given the nominal goal of each fund class, but would make a difference in the tax paid. If the charge was 0.5%, then switching from a capital to income charge would change a 3.5% dividend to 3%, resulting in less exposure to dividend tax, but more to CGT.

    Other providers may be doing the same, so keep an eye out, especially if dividends rise and take you into a taxable band.

  • 59 The Rhino June 8, 2016, 6:51 pm

    from my experience with HL and iweb you do get a tax cert which tells you what the divis were for any acc units in a given tax year. This makes it pretty easy to fill in your return. its also quite nice that you don’t have to declare and CG if its below the thresholds as given on the hmrc site. So assuming your not making some large sales, acc units can be pretty painless in taxed accounts.

  • 60 Dragon June 8, 2016, 8:05 pm

    The issue I have with Acc units is that the “dividend” simply pumps up the value of each unit, you don’t actually get any more units. This means that if the value of the Acc unit goes down, you’ve effectively lost any benefit of that “dividend”.

    With the Inc units, you get a divi paid out as cold hard cash, which you then *can* use to buy more units, or else just enjoy the £. If the capital value of the unit goes down, at least you have either (depending on what you did with the divi) (a) more units (if you reinvested), or (b) a higher bank balance (if you simply took the cash and saved it).

    Given markets (in the UK at least) seem to be drifting sideways (and frankly, seem to have been for years), Inc units from which you’ve had an income paid out to you seem (to me, psychologically), to be “better” than divis being “retained” in the Acc unit, which saw a slight increase in the unit price, but which didn’t get you any more units, and then promptly tanked in value following the latest credit crunch/herd panic/brexit worry/remain worry/Greek debt crisis/general Euro crisis/US interest rate rise/war/death/pestilence/famine/[insert preferred black swan event here]

    🙂

  • 61 The Rhino June 8, 2016, 8:49 pm

    @Dragon – thats pretty shaky stuff there, not that rational. What if the market goes up?

    You don’t have to worry about what seemed to happen in the past, as the data is there, we know what happened, i.e.

    http://www.forecast-chart.com/historical-ftse-100.html

  • 62 Dragon June 8, 2016, 10:43 pm

    Hence why I said “psychologically” 🙂

    If the market goes up, great. My Inc units are worth more *and* I’ve had an actual divi, instead of something that looks suspiciously like an accounting exercise.

    Interesting link you sent. Looking at that, if you start from 2008, in very crude terms, it looks suspiciously like it takes you all of 2009 and 2010 to cancel out 2008. 2011 and 2012 pretty much cancel each other out. 2013 was good and then 2014 goes down again. So in 6 years, in real terms, an increase in only 1 year. Now, OK, that’s a relatively short period in share terms, and things will look different for other indices, but for the UK’s bellweather index, that’s a pretty depressing pattern.

    In some ways, that info only really serves to show that market timing (and reinvesting divis) is all! i.e. if you invested at the height in 2007, on a capital value basis only, you may well still be underwater, even now. On the other hand, if you invested at the low in 1994 and sold out at the height in 1999, you made

    The FTSE 100 barely staggered over 7,000 in March and April last year. Given it was just shy of 7,000 in December 1999 and is currently at 6,300, that looks like going sideways to me, at best. And that over a 15 YEAR period. Which is starting to look like a long time!

    Obviously the performance of individual shares will vary widely.

    Interesting article here:-

    http://www.telegraph.co.uk/business/2016/06/05/four-lessons-from-a-decade-of-shares-slip-sliding-away/

  • 63 Richard June 9, 2016, 10:18 am

    @John B – Are you sure that’s how it works? Surely a 3.5% dividend will be taxed as such. The fact that the provider takes the cash fees from that dividend is irrelevant for the tax calculations. My understanding is that direct purchase and sales costs (“dealing” costs, including stamp duty) can be allowed for in CGT calculations but not general platform charges (“holding” and “management” costs) and the like.

    @Rhino – I’ve found the HL tax certificates to be clear and helpful…but far too slow. I like to complete my tax return on 7th April (usually because HMRC owe me money). This year the tax cert arrived 24th May.

    The problem I’ve found with (non-wrapped) accumulation funds is the “Equalisation payments”, which is a lowering of cost for CGT purposes. Bit of a pain as – potentially many years in the future – I may have to work out a purchase price that is not as simple as “cost of share bought less any dealing fees”. Keeping good records is the key…

  • 64 John B June 9, 2016, 12:24 pm

    Their example suggested switching charges from out of income to out of capital would increase the INC payout and increase tax. I threw away the piece of paper though.

  • 65 The Rhino June 9, 2016, 2:46 pm

    @Richard – wow, that is unbelievably organised, less than a week in and its done. I’m more of a late december kind of guy as the deadline looms – so at that end of the spectrum a may tax cert delivery is not a problem

  • 66 Fremantle June 9, 2016, 4:00 pm

    I have a mix of accumulating/capitalising funds/ETFs and distributing ETFs. I do like the sense of winning the investment game that dividends provide, but they also provide cash for my small Australian super account that requires minimum cash balances for fees.

  • 67 Tim June 11, 2016, 1:02 am

    I used to invest all ACC units back in the ’90s and ’00s (and I’m glad I did), but then when I started migrating holdings to online platforms I found I preferred the flexibility INC units gave me to redeploy the income elsewhere (and at some point I anticipate living off it). By the time the FTSE100 had got up to 7000 I was redirecting most of my portfolios’ yield into property and fixed interest. As it sunk back to 6000 I steered the income flow back towards reinvesting in equities. With ACC units I wouldn’t have had that freedom… sure, I could just sell and buy ACC units to achieve any target asset allocation, but using the dividend flow to take me towards where I want to be seems a smoother ride and probably keeps me from overreacting. The way things are currently I don’t mind rolling up cash to keep dealing-cost impact under control (or to wait and see what happens with the referendum for that matter).

  • 68 Planting Acorns June 13, 2016, 1:00 pm

    So I came to the site last year and managed to come up with answers that I think suit me best as regards the following :

    -Proportion savings o/pay mortgage/proportion to invest

    – Pension or ISA

    – Shares / Actively managed funds/ Passive funds

    BUT…I’m the 68th commentator on here and for ISA or pension investors the INC/ ACC question appears to be akin to Coke / Pepsi :0)

    I set up ACC units in a drip feed and leave strategy…but secretly wish I could see the divis “rolling” in …

  • 69 The Accumulator June 13, 2016, 8:31 pm

    Hi PA, I agree. You can record them rolling in by following the instructions here: http://monevator.com/accumulation-funds-dividends/

    Tells you how to find out your ACC units dividends.

  • 70 Planting Acorns June 15, 2016, 8:58 pm

    @PA… thanks… I tried that and it is no quite the same :0)

    I know this sounds nuts, but I have six funds I actively contribute to…and I think I’m going to buy £100 worth of INC of each one…that way I can see what dates the dividends are paid and what pc they were…then simply multiply that by £amount of ACC funds to see what my total dividends were…

  • 71 The Accumulator June 16, 2016, 6:13 pm

    Haha. I sympathise and can see the method in your madness 😉 Be careful the divis aren’t different.

  • 72 Planting Acorns July 16, 2016, 10:25 am

    @anyone using Charles Stanley Direct

    You can see the dividends received in Accounting funds by going to

    – dashboard, my direct accounts, stock movements

    Very interesting I might add ;0)

  • 73 Eddy August 5, 2016, 1:09 pm

    What about recurring investments?
    In comment 24 TA suggests that tracking CG is easier with Acc than Inc funds. I think that’s true in the specific case of a one-off investment where you reinvest dividends. But if I make recurring investments, I need to keep track of total cost of lots of purchases anyway, whether I buy Acc or Inc.
    And if I sell part of my investment, I need to adjust my cost basis, again whether I am in Acc or Inc.
    In fact, I think my broker should report my total cost anyway. For Inc shares, this is the same as my cost basis for CGT purposes, but this is not so for Acc shares as has been discussed on this thread.
    So it seems to me that for taxable accounts where you are making recurring purchases and/or sales, you will be thankful come tax day that you use Inc rather than Acc.
    Does that make sense?

  • 74 Kraggash August 12, 2016, 12:01 pm

    Calculating CGT on Acc funds can be horrible, and allowing for the conversion from dirty to clean funds (the clean fund often has a different unit price) when you come to sell the clean one adds another complexity.

    I have found Fidelity provide a tool to calculate CGT incurred, that allows for income reinvested and equalisations. You can also see CG to date, to allow you to keep below the allowance. Very nice.

    Youinvest say they provide CG calc at end of year- useful, but you cannot see ‘year to date’.

    iWeb do not provide anything to do with CG calculation.

    K

  • 75 The Accumulator August 12, 2016, 1:34 pm

    Hi Kraggash. Thanks for the tip! Would you mind posting a link to the calc? Cheers!

  • 76 Kraggash August 12, 2016, 1:58 pm

    In case I was not clear: it only does it for the holdings you have with Fidelity platform, so you have to log-on to their site. It is a platform value-add that is something to consider rather than ‘just’ fees. It is under ‘Capital Gains Reporting’ under ‘Your Accounts’

    Incidently you have to log-on selecting ‘investing personally’ (if you get the option) to see the CGT tool. If you select ‘investing with an advisor’ – eg if you are going via Cavendish – you do not see the tool.

    K

  • 77 Ray January 5, 2017, 8:16 pm

    I am new to self-investing and indexes etc. I have most investments in accumulation. I am retired but not taking income just yet. My question is……if the markets went pear-shaped how would that impact on the two types of investment? (monosyllables would be good for me guys 🙂 )

  • 78 The Accumulator January 8, 2017, 10:10 pm

    Hi Ray, it would impact acc and inc units in exactly the same way. Apparently US dividends were cut 50% during the Great Depression. I don’t remember seeing anything about how much dividends were cut during the 2008 crisis but a good Google search would probably conjure something up.

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