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Cost and taxes when selecting ETFs

This article is part of
Guide to ETFs

“These cost components often overlap and may be used inconsistently from one issuer to another.

“Additionally disclosure of portfolio transaction costs like swap fees or index replication fees may be missing, partial or inconsistent (for example, appearing on product factsheets but not on website cost pages).”

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The most important costs faced by an investor investing in an ETF are the ongoing charges and portfolio transaction costs, says Mr Lansing. Together he says these costs add up to what can be terms the “holding costs”.

Mr Lansing says: “Understanding holding costs is crucial when making comparisons across investment products. The ongoing charges figure is a measure of the recurring costs faced by an investor in an ETF.

“It typically covers the cost of investment management, administration, custody and oversight, index license fees, storage costs, collateral fees and insurance costs.”

Another key consideration for advisers recommending ETFs to investors is tax.

ETFs are generally taxed like all Ucits funds, so Mr Lansing says advisers should consider both taxation at the fund level as well as at the investor level.

Items to consider for fund-level taxation include any portfolio level withholding tax and relevant treaty rates, as well as the extent to which a fund has to pay tax on any gains from the disposition of the assets it holds.

In general, he says most ETFs do not pay any tax on, and there is no withholding on, distribution of portfolio income, nor do they pay tax in their countries of domicile.

For investor level tax, Mr Lansing says each investor must consider his or her own tax position before investing in an ETF.

This includes the taxation of distributions such as equity dividends (generally taxed as dividends) and interest from bonds (generally taxed as interest). It also includes the taxation of any gains from the disposition of an ETF unit.

In general, gains from a disposition will be taxed at the relevant capital gains rate.

For ETFs that are not domiciled in the UK, Mr Lansing says investors should take care to ensure that the ETF has reporting fund status.

Finally, he says few ETFs are subject to stamp duty. “Investors should take great care to understand the taxation of an ETF (as with all funds) before investing, and to consider how their own personal tax circumstances may be affected,” he added.