What Is Distribution?

The word "distribution" has several meanings in the financial world, most of them pertaining to the payment of assets from a fund, account, or individual security to an investor or beneficiary. Retirement account distributions are among the most common and are required after the account holder reaches a certain age. A distribution also refers to a company's or a mutual fund's payment of stock, cash, and other payouts to its shareholders.

Distributions come from several different financial products; however, whatever the source, the distribution payment usually goes directly to the beneficiary, either electronically or by check.

How Distributions Work

In finance, a distribution can mean many things; however, the term is used most commonly to describe the following situations:

1. When a mutual fund distributes capital gains, dividends, or interest income to fund owners
2. When a publicly traded company distributes interest or returns capital to shareholders
3. When a retirement account owner takes distributions in the form of taxable income

Regardless of the situation, distributions can generally be regarded as "cash" that goes straight into your pocket.

Distributions From Mutual Funds

With mutual funds, distributions represent the allocation of capital gains and dividend or interest income generated by the fund for the investors periodically during a calendar year.

One common type is the net capital gains distributions that come from profits on the sale of a mutual fund's holdings. For example, if a stock is bought for $75 and later sold for $150, the capital gains are $75 minus the fund's operating expenses. The exact amount of the distribution is tallied after the subtraction of these operating expenses.

Once dividends and distributions are disbursed, the fund’s share price declines by the total of the per-share distribution to the fund’s shareholders. The price falls because the distribution is withdrawn from the fund’s assets, which decreases the net asset value (NAV).

Stock and Bond Distributions

With securities like stocks or bonds, a distribution is a payment of interest, principal, or dividend by the issuer of the security to the shareholders or bondholders. When a corporation earns a profit, it can reinvest the funds in the business, but may also pay a portion of the profit to shareholders in the form of a dividend. Sometimes the company offers a dividend reinvestment plan, where the amount can be applied to buying additional shares of the stock or fund. Without a reinvestment plan, the funds flow into the investor's account as cash.

Investment Trust Distributions

The income generated from an investment trust is awarded to investors, typically as a monthly or quarterly distribution. For this reason, distributions function similarly to stock dividends; however, distributions typically offer higher yields that can be as high as 10% a year. The distributions received lower a trust's taxable income and, as a result, little or no income tax is paid.

Retirement Account Distributions

Distributions from a traditional individual retirement account (IRA) can happen at any time after the creation of the account. Retirement account distributions fall into two categories:

1. Distributions before age 59½ are subject to an IRS penalty and ordinary income tax. Many IRA owners may face these fees if they use the IRA funds to make large purchases or for an emergency because the funds were untaxed when being deposited into the account.
2. During or after an individual reaches age 59½, distributions incur without the penalty; however, taxpayers will still pay tax on the sums withdrawn at their current tax bracket.

Roth IRAs also generally require the funds to remain in the account until age 59½ before distribution. After the account has been in existence for a certain number of years, account holders may withdraw funds early but will pay penalty fees if they withdraw a sum greater than their contributions—if the distribution includes the account's earnings, in other words.

Other retirement accounts also have age limitations for withdrawals without penalties.

Distributions from qualified plans, such as 403(b) accounts and 457 plans, are two examples of such plans. Specific public school employees, members of religious orders, and other tax-exempt groups have 403(b) plans. The 457 plans contain deferred salary contributions and are mainly used by state and local governments.

Required Distributions From Retirement Plans

Except for the Roth IRA, all retirement plans mentioned earlier require the holder to begin withdrawing funds once they reach the age of 73 if they were born between 1951 and 1959 or 75 if they were born in 1960 or after. The exact amount of this annual required minimum distribution (RMD) depends on the account holder's age and the value of funds in the account, as per .

All distributions from these retirement accounts are taxed based on the individual's tax bracket at the time of withdrawal. The tax assessment reflects the fact that contributions to the account were made with pretax dollars.

Note that only distributions from Roth IRAs or Roth 401(k)s can be taken without income tax being due on them because Roth contributions are made with after-tax dollars—the investor didn't receive a tax deduction or credit at the time. Further, the Roth accounts do not have the required minimum distributions at any age.

Real World Example

The Fidelity 500 Index Fund (FXAIX), which seeks to duplicate the performance of the S&P 500, disburses dividend distributions quarterly (in April, July, October, and December).

In 2022, investors received $0.462, $0.577, $0.581, and $0.636 for every share of the fund they owned for April, July, October, and December, respectively. Unless a customer specifies otherwise, Fidelity automatically reinvests these distributions, increasing the number of shares of the fund owned.

The Bottom Line

In the world of finance, a distribution generally refers to the disbursement of assets from a fund, account, or individual security to an investor.

By understanding the ins and outs of various types of distributions—their purpose, how they're used, and how they work—you won't be left scratching your head when you hear the term thrown around during your investing life.