What is dividend leakage and how do you prevent it?

When you invest in ETFs, you may encounter dividend leakage. A portion of your dividend is lost, even though you are actually entitled to it. But what is dividend leakage, and how can you prevent it?

What is dividend leakage?

In the Netherlands, dividends are taxed at 15%. In other countries, this percentage can be much higher; for example, in the United States it is 30%. If you are unable to recover this higher percentage from the tax authorities, we speak of dividend leakage. Dividend leakage can therefore cause your returns to be lower.

The three scenarios of dividend leakage in brief (in case of 15% dividend taxation in your country):

  • There is a tax treaty and 15% is taxed at the source: You receive $0.85 in your account for a dividend of $1. You can reclaim the $0.15 to your account.
  • There is a tax treaty, but no account is taken of this at the source: In this case, for example, you pay 30% dividend tax. You can offset 15% with your tax return and try to get the remaining 15% back from the relevant government.
  • There is no tax treaty, and you pay more than 15%: In this case, there is dividend leakage.

How can you prevent dividend leakage?

The only way to completely prevent dividend leakage is to only trade in funds registered in your country. It is also important that the fund only invests in stocks listed on the stock exchange of your country.

How can you recover dividend leakage?

It is not always possible to recover dividend leakage. How easy this is, strongly depends on the tax treaties that exist between your country and the country in question.

How high is the dividend leakage?

The amount of dividend leakage depends on the fund in which you invest. If you invest in a foreign fund with shares that pay out many dividends, the dividend leakage can be much higher than if you invest in a technological ETF.

Suppose you receive an average of 3% dividend and the dividend leakage is 10%: in that case, your return will be 0.3% lower on an annual basis due to the leakage of the dividend.

How do you calculate dividend leakage?

You can calculate the dividend leakage of a fund by looking at the amount of dividend the fund pays out and the taxes that are withheld on it. However, it remains difficult to calculate this percentage exactly, as dividend leakage can occur at different times.

You may encounter dividend leakage when stocks pay dividends to the fund and when the fund pays dividends to you.

How important is dividend leakage?

Now that you have a better understanding of what dividend leakage is, you may be wondering how important it is. If you can choose a comparable fund with a lower level of dividend leakage, this is of course favourable. Your return can then be higher because less dividend leaks away.

At the same time, your return can be higher when you also invest in more exotic regions. Emerging economies, in particular, have a lot of room for growth. Therefore, do not focus solely on dividend leakage; it is better to have a high level of dividend leakage and a high return than to have little dividend leakage and a low return.

Frequently Asked Questions about dividend leakage

You can fill out a W-8 form to prove that you have no direct ties to America. By filling out this form with your broker, you can avoid dividend leakage on investments in America.

Dividend is a profit distribution. When a company makes a lot of profit, it may decide to pay a portion of it directly to the shareholder as cash. In this article, you can read more about dividends.

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