Covered call ETFs, popular with baby boomers for monthly income, carry tax complications that can significantly reduce after-tax returns. The mix of ordinary dividends, capital gains and return-of-capital distributions often surprises investors at tax time.
01Summary
- 01Covered call funds generate income by selling call options, but option premiums and short-term gains produce taxable distributions.
- 02Return-of-capital distributions reduce an investor’s cost basis, deferring but not eliminating the tax liability until shares are sold.
- 03A JPMorgan Equity Premium Income ETF (JEPI) has a three-year tax-cost ratio of 3.11, reducing after-tax returns by over 3 percentage points annually for top-bracket investors.
- 04The Neos S&P 500 High Income ETF (SPYI) has a three-year tax-cost ratio of 0.48 due to a higher return-of-capital component.
- 05Advisers recommend holding covered call ETFs in tax-deferred accounts such as traditional IRAs to avoid immediate tax impacts.
02Why it matters
Many investors assume ETFs are tax-efficient, but the short-term income from covered call strategies creates a higher tax drag that can significantly reduce net returns. Understanding the taxCost ratio and choosing the right account type can avoid an unpleasant surprise at tax time.
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