Congratulations! You’ve just inherited £100,000 from Great Uncle Bertie.
Good old Bertie. Always liked him.
Naturally, you’re going to invest this for your future financial well-being. The pleasantly unexciting Vanguard LifeStrategy 60 will do nicely.
Your tax allowances are already spoken for. So, at least for now, you’ll need to resign yourself to paying tax on your gains in a General Investment Account (GIA).
You also know that investing everything ASAP is statistically the best approach.
However, (our hypothetical) today is the 31 March and the fund goes XD tomorrow.
Should you invest today or wait until tomorrow? What is XD? Does any of this even matter?
If you don’t want the detail, then the short answer is it matters a bit in terms of tax but for the most part you can ignore it.
But if you don’t want the detail then why are you reading Monevator?
Let’s get into it.
Dividends
Most funds generate regular dividends. They could be paid annually, bi-annually, quarterly or monthly.
The dividends are either paid out to you in cash if you hold the income (inc) unit class or are rolled up in the fund if you hold the accumulation (acc) class.
Dividend dates
There are two key dates associated with a dividend payment:
- The XD (ex-dividend) date
- The payment date
If you buy before the XD date, you are entitled to the dividend payment. Whereas if you buy on or after the XD date, you must wait for the next cycle to receive your first dividend.
The payment date, when the cash is paid out, is usually a month or so after the XD date.
The unit price of the inc class will usually drop on XD date to compensate for the cash payout. Thus, the inc and acc unit prices will gradually diverge over time – even though the total return is the same.
Vanguard’s LifeStrategy 60% fund pays a dividend just once a year, currently of around 2%. The last XD date was 1 April and the payment date was 29 May.
Tax
I’ve been liberally using the term dividends, but the specific tax classification of income distributions depends on the type of fund:
- Distributions from funds investing predominantly in equities are taxed as dividends.
- Funds holding more than 60% of their assets in interest-bearing investments, such as bonds or cash, instead pay interest distributions, which are taxed as savings income.
Your LifeStrategy 60 distributions will therefore be taxed as dividends.
The tax treatment of inc and acc classes is the same. You still pay the same amount of dividend tax – regardless of whether you get paid the dividend in cash or it gets rolled up in the fund.
Many investors choose to hold the inc class in a GIA. It’s easier to see what’s going on and, if you must pay tax, it’s nice to have some cash hitting your bank account.
Of course, if you have all your investments in ISAs and pensions then you don’t need to worry about dividend tax.
Equalisation
Now, those fair-minded fellows at HMRC recognise that if you only bought the fund just before the XD date then it would be a bit mean to charge you tax on the whole dividend payment.
In effect, you are just getting some of your own money back with the dividend – a return of capital as it’s known.
So your first dividend payment on a fund holding is part ‘equalisation’ (on which you don’t pay dividend tax) and part dividend (on which you do).
You will see this distinction in the annual consolidated tax certificate from your platform.
But you’ll need to take the equalisation amount off your purchase price when you come to calculate capital gains on any disposals.
In other words, equalisation just means you pay a bit less dividend tax but a bit more capital gains tax. The tax man will get you one way or another.
Note that equalisation applies to UK authorised funds – for example, OEICS and unit trusts – but not generally to ETFs.
Group 1 and Group 2
You may occasionally see reference to Group 1 and Group 2 units.
Group 1 units are those you bought during the current dividend cycle.
Once the XD date is reached, your Group 1 units become Group 2 units.
The equalisation rate per unit is calculated by the fund manager based on what they reckon Group 1 holders on average paid for the accrued income versus Group 2 holders.
But this is just an average. Every Group 1 holder gets the same equalisation rate regardless of when they bought the units.
So the equalisation for investor A who bought on the last XD date is the same as the equalisation for investor B who bought the day before the current XD date.
Back to Bertie’s money
Finally, back to the original question. Does it matter if you invest pre-XD or post-XD?
The table below compares the two scenarios: buying pre-XD and buying post-XD.
We’ll assume an investment of £100,000, a distribution yield of 2%, an equalisation for Group 1 units of half the total distribution, an initial price of 100p, and a final price of 103p:
| Pre-XD | Post-XD | |
| Purchase date | 31/03/2026 | 01/04/2026 |
| Purchase price | 100p | 98p |
| Units | 100,000 | 102,040 |
| Dividend | £1,000 | £0 |
| Equalisation | £1,000 | £0 |
| Sale date | 31/03/2027 | 31/03/2027 |
| Sale price | 103p | 103p |
| Sale proceeds | £103,000 | £105,100 |
You end up with roughly the same returns in both cases: Pre-XD gets some income, but post-XD gets more capital gain.
The extra £100 gain for the post-XD case is offset in the pre-XD case by the early £2,000 distribution in dividend and equalisation, which can be reinvested elsewhere for most of the following year.
In tax terms, the difference between the scenarios looks like this:
| Pre-XD | Post-XD | |
| Taxable dividends | £1,000 | £0 |
| Taxable capital gains | £4,000 | £5,100 |
The pre-XD taxable capital gain is £4,000 because the £1,000 equalisation must be deducted from the purchase price.
In summary then, there is negligible difference in the returns you get, but when investing pre-XD you are swapping some capital gains tax for dividend tax.
Does that make much difference? Depends on your tax situation.
Tax impact of going ex-dividend
The table below shows the approximate difference in the tax you pay for various tax situations. (There is no case for 0% capital gains tax as the £3,000 capital gains allowance is more than used up by the gains in either scenario):
| Tax Situation | Dividend Tax Rate | CGT Rate | Pre-XD vs Post-XD |
| Nil-rate taxpayer | 0% | 18% | Pre-XD saves ~£200 |
| Basic-rate taxpayer | 10.75% | 18% | Pre-XD saves ~£90 |
| Higher-rate taxpayer | 35.75% | 24% | Post-XD saves ~£90 |
| Additional-rate taxpayer | 39.35% | 24% | Post-XD saves ~£130 |
I’m using the new 26/27 dividend tax rates as dividends are taxed in the tax year in which the payment falls and not necessarily the XD date.
(As an aside, who decided we needed tax rates specified to two decimal places?)
If you’d held on to the investment for longer, then there would also be a difference in when you pay the tax.
The initial dividend tax must be paid for this tax year whereas the capital gain tax could be deferred until later tax years by not selling.
Price fluctuations
There’s a lot of detail I’ve glossed over.
Most notably, I’ve assumed that, on the XD date, the unit price of the fund drops by the same amount as the dividend paid.
In reality, it will not be the same, as it will also be affected by fluctuations in the prices of the assets in the fund.
In scenario two you are buying a day later. Might the price change on that day have a bigger effect than the different tax rates? Who knows.
Or maybe the price goes down over the year, so the bigger capital gain becomes a smaller capital loss.
So what?
Some of you may enjoy the thought of saving a few quid in tax with some judicious ex-dividend timing.
I suspect that most, though, will be thinking that this is all just noise when considered against investment returns – and you’re probably right.
So whilst it’s worth knowing exactly how you’ll be taxed on dividends if you have assets outside of a tax wrapper, it’s probably not a good idea to spend time trying to game the tax system at the risk of losing investment gains.
But, looking on the bright side, I think we can all agree that stuffing all the investment fun stuff – dividends, tax, and equalisation – into just one short article is a joy to behold.
You’re welcome!
