Accumulation vs income funds: how they work and the pros and cons

Funds can be a popular choice for investors by allowing them to pool their money with others and access various investments. 

Not only does this investment fund offer diversification, but it also lowers the overall risk. 

But what if you have to choose between an ‘accumulation’ and ‘income’ fund?

We explain what these are, how they work and the advantages and disadvantages of each.  

What is an accumulation fund? 

An accumulation fund reinvests dividends with no charges, boosting the price of each unit and raising the value of your investment. You can identify this fund if ‘Acc’ is included in the name.  

If you opt for an accumulation fund, you can benefit from compounding, where you earn returns on both the initial amount you invest and your returns.  

While the initial gains may appear small, these can snowball into bigger returns.  

As these funds focus on income, they will invest in companies or areas with good growth potential, such as technology companies. 

Accumulation funds are good for investors who don’t need returns immediately and hope to boost their money.  

What is an income fund? 

An income fund pays out any interest and dividend income as cash into your account, usually on a regular basis. You can identify this type of fund with ‘Inc’ in its name.  

Income funds usually invest in shares in relatively stable companies that pay out regular dividends. 

So, this option is good if you want income instead of focusing on boosting your investments.  

The pros and cons of accumulation funds 

There are many advantages of accumulation funds, including: 

• Dividends are reinvested automatically and with no charge. 
• Savings on commission costs as you don’t need to reinvest dividends manually. 
• The chance to benefit from compounding and hopefully boost the value of your investments. 

But there are some disadvantages, including: 

• Accumulation funds are not ideal if you’re not happy investing long-term. 
• No dividends or income is paid out, which can be difficult if you need the money. 
• If you want cash, you’ll have to sell the fund. 

The pros and cons of income funds 

Income funds have many benefits, including: 

• The ability to draw a regular income from these funds via dividends. 
• You can choose to do what you want with your cash. 
• More flexibility with your investments as you can put your money into other assets. 

However, there are some drawbacks, including: 

• If you don’t reinvest dividends, you’re unlikely to benefit from compounding, and you won’t be able to potentially increase the value of your investments in the long term. 
• If you do decide to reinvest dividends, you have to do this yourself and may need to pay a fee.  

Still struggling to decide between an accumulation and an income fund?

An independent financial adviser can look at your circumstances and recommend the right strategy and fund for you.  

Can I switch the type of fund? 

You can switch the type of fund after you’ve chosen one. 

For example, if you’re invested in an accumulation fund and want regular payments to supplement your retirement, you can switch to an income fund. You may be charged a fee, so it’s a good idea to check beforehand.  

If you’re not using an individual savings account (ISA), switching funds means selling the current one for a new one, which may trigger capital gains tax – if it exceeds your annual allowance. 

And if you want to reinvest dividends, it is possible to do it yourself, but you may incur a fee.  

How to buy income and accumulation funds 

You can buy income and accumulation funds directly via an investment platform, or a financial adviser may be able to purchase one for you.  

It’s worth having a long-term plan for your funds and understanding the potential benefits, risks and fees before investing, as well as shopping around. 

Are income and accumulation funds taxed? 

Both funds are taxed the same. You won’t get taxed on dividends and profits if your investments are in an ISA or self-invested personal pension (SIPP). 

If you hold your investments in a dealing account, it is taxable.  

Most people get an annual personal savings allowance, while everyone gets a dividend allowance and capital gains tax allowance (the latter is on any increase in value when you sell). 

If you're considering investing and need guidance, an independent financial adviser can help.

Unbiased can connect you to an FCA-regulated adviser who can recommend the best strategy and investments based on your circumstances and future goals.