Index funds/Exchange Traded Funds (ETFs) are an excellent vehicle to grow your savings. They have better returns than most active investment funds. They have lower fees than active investment funds and private retirement saving funds (i.e. PPRs – Planos Poupança e Reforma).

This guide focuses on aspects of investing in index funds which are specific to residents in Portugal: taxes, brokers, alternatives, useful links. Check my article “Step by step guide to investing” if you are looking for information about investing in index funds which is applicable to residents across Europe.

Table of Contents

• Why should you invest in index funds?
• Index funds in Portugal
• Fund Domicile
• ETF Suggestions
• Brokers
• Taxes
• Planos Poupança e Reforma (PPRs) – private retirement saving funds
• Summary

Why should you invest in index funds?

An index fund (also known as passive fund) is an investment fund that replicates the financial performance of an index (e.g. S&P 500, MSCI World). Index funds are different from active funds where the investment managers attempt to have better returns than the index. An index can be constituted by equities, bonds or other assets.

Index funds have lower fees (as measured by TER – Total Expense Ratio) than actively managed funds. Index funds tend to have fees which are lower than 0.3% annually while active funds tend to have fees which are higher than 1.5% annually.

The difference between paying 0.3% and 1.5% may not look big. But it can result in having a portfolio worth €802 811 (fund with TER 0.3%) or €647 524 (fund with TER 1.5%) if we consider an investor which contributes €10 000 every year with a rate of return of 6% over 30 years. You can use this calculator to simulate such scenarios.

Index funds typically have returns which are higher than many active funds. The European Securities and Markets Authority (ESMA) has published a report where it shows that from 2009 to 2018 only the top 25% of active funds outperformed the index. Yet the actual funds in the top 25% changed over time, making it very hard for investors to pick the winning funds. According to historical data, an index fund investing in companies of the whole world, has had an average annual real return of 5% (i.e. excluding inflation) in the long term (i.e. > 30 years).

Index funds investing in companies are a more appropriate vehicle to grow your savings than a savings account. Many savings accounts currently (September 2019) have interest rates in the order of 0%. Savings account are only appropriate to preserve savings due to their low risk.

Index funds allow to invest in the long term in order to complement your income during retirement. This study estimates that a Portuguese retirement corresponds to a 30% reduction in income. The invested capital can help you maintain your desired lifestyle.

Index funds in Portugal

In the USA you can buy shares in mutual index funds. Shares of mutual index funds are sold directly by the fund provider.

In Portugal, the easiest way to have access to index funds is through ETFs. These funds’ shares are traded in a stock exchange similarly to how shares of a company like Apple are traded. Shares of ETFs are traded with other market participants instead of being acquired from the fund provider.

Buying/selling shares of ETFs requires having an account in a broker.

Fund Domicile

Fund domicile is the location where the fund is legally incorporated. To learn more about fund domiciles please read my article on the topic.

Portugal has a dividend tax withholding treaty with the US. This treaty reduces dividend tax withholding of US domiciled funds from 30% to 15%. The remaining 13% of dividend tax are paid in Portugal.

Portugal does not have an estate tax treaty with the US. US domiciled funds are not recommend to residents in Portugal due to the estate tax charged for assets over 60k €. Additionally, ETFs domiciled in the US are not available to most brokers due to European laws (i.e. MiFID e PRIIPS).

Prefer funds domiciled in Ireland if investing in ETFs with holdings in American companies. Prefer Ireland or Luxembourg domiciled funds for other cases.

ETF suggestions

My article on investment portfolios covers my ETF suggestions. The strategy outlined there does not change for Portugal. There is only a preference for accumulating ETFs due to their fiscal benefits.

Subscribe below to my free email course to learn how to choose an ETF for your portfolio.

Brokers

DEGIRO is the cheapest broker in Portugal. Specially when one considers that some of this blog’s recommended ETFs don’t have commissions in DEGIRO.

DEGIRO is a Dutch broker which is available in Portugal. Another international broker with reasonable prices is Interactive Brokers. Local alternatives to these brokers include: Banco Best, Banco BIG, Banco Invest and Banco Carregosa.

In the table below you can find a comparison of costs among the most important brokers.

Brokers in Portugal

Taxes

Fiscal year

The fiscal year is from January 1st to December 31st. Each tax declaration only has to include details of transactions done within the same fiscal year.
Submitting a tax declaration is mandatory for everyone that receives an income.
Tax declarations are usually submitted from April and apply to the previous civil/fiscal year. Submission deadlines may vary depending on the year.

Tax Rates

Most income (e.g. salary) is grouped into a total called taxable income (i.e. rendimento coletável). For a given taxable income, the final effective tax rate is calculated based on marginal tax rates which progressively increase.

ETFs are taxed similarly to stocks. They are taxed independently of the taxable income at a fixed rate which is independent of the total amount involved in the transactions.

There isn’t any exemption of taxes over capital gains or dividends.

Capital gains

The positive balance of capital gains/losses is subject to a tax rate of 28%.

A capital gain is a profit – the sale price is higher than the purchase price – a capital loss happens when the sale price is lower than the purchase price.
The balance is calculated by doing the subtracting the capital gains by the capital losses (i.e. balance = total(gains) - total(losses).
The balance is taxed only when there is a sale of shares of the ETF. If you haven’t sold anything, no tax is due.
Taxes are only charged when the balance is positive (total(gains) - total(losses) > 0).

Example 1: Losses

Buy: 1 share of an ETF for 100€ on January 1st
Sell: 1 share of the same ETF for 50€ on February 2nd
Balance: -50€ (50€ – 100€)
Taxes: No taxes are due because the balance is negative

Example 2: Gains

Buy: 1 share of an ETF for 100€ on January 1st
Sell: 1 share of the same ETF for 170€ on February 2nd
Balance: 70€ (170€ – 100€)
Taxes: 70€ * 28% = 19.6€

Dividends

Dividends are subject to a tax rate of 28%.

Englobamento

Alternatively to paying a fixed tax rate of 28% for dividends/capital gains, you can do an “englobamento” of your IRS. This process adds your dividends/capital gains to your taxable income which means they will be taxed at progressive tax rates.

“Englobamento” isn’t advantageous in most cases.

It is only useful for people with a taxable income which leads to effective tax rates which are lower than the fixed 28% tax rate.

“Englobamento” is also useful when you have losses. It allows you to carry your losses for the 2 following years which can lead to reducing your taxes in those years. In order to deduct your losses from the previous years you will have to opt for “englobamento”. You will still have to evaluate if it is worth using your previous losses. You will have to assess which method leads to less taxes: paying a fixed tax rate without deducting previous losses; paying progressive tax rates while deducting your previous losses.

When are taxes paid?

In some cases dividend/capital gains taxes are withheld. This means that taxes are paid when the transaction happens (e.g. sale, dividend processing). In these cases you don’t need to declare the transactions in your tax declaration (unless you choose to do an “englobamento”).

Generally taxes are withheld when using a Portuguese broker.

If you invest through a foreign broker (e.g. DEGIRO, Interactive Brokers) in ETFs domiciled in Ireland/Luxembourg, taxes won’t be withheld. Therefore, you will have to indicate your transactions in the annual tax declaration. Payment is done when the declaration is processed. In this case you may receive a lower tax refund or have to do an additional payment to the IRS.

Brokers generally indicate which taxes where withheld in their annual transactions report. You can use that information to assess what you need to declare.

How to fill a tax declaration?

The tax declaration is a set of forms organized into annexes. Each annex (i.e. “anexo”) is meant to be used for a certain type of income/deduction. This article describes all annexes.
The annual tax declaration is submitted online through an application in the “Portal das Finanças”.

Anexo J

Fill “anexo J” if you have capital gains/dividends in a foreign broker (e.g. DeGiro, Interactive Brokers).
This is a paper representation of it which is equivalent to the version you find online. It has instructions on how to fill it.

Capital gains are registered in the table 9.2 A (“Incrementos patrimoniais de opção de englobamento” / “Alienação onerosa de partes sociais e outros valores imobiliários”).

The columns of the table should be filled the following way:

• País da fonte – Country of the broker. “Países Baixos” for DeGiro. “Estados Unidos da América” for Interactive Brokers
• Código – G01 (Alienação onerosa de ações/partes sociais)
• Realização – date and amount of sale
• Aquisição – date and amount of purchase
• Despesas e encargos – broker commissions of purchase/sale
• Impostos pago no estrangeiro – fill if there was any foreign tax withholding. ETFs domiciled in Ireland/Luxembourg don’t have tax withholding.

A line should be added for each traded allotment. A single sale may contain multiple allotments of shares. An allotment of shares is a group of shares of an ETF which were purchased at the same date/price. If you don’t sell all your shares you need to choose allotments by date of purchase (i.e. FIFO method). Sale expenses need to be divided proportionally between allotments.

Consider the following transactions:

Purchase #1
Date: 01/01/2018
Share price: 50€
Number of shares: 1
Commission: 1€
Total: 51€
Purchase #2
Date: 01/03/2018
Share price: 70€
Number of shares: 1
Commission: 1€
Total: 71€
Sale #1
Date: 01/04/2018
Share price: 65€
Number of shares: 2
Commission: 1€
Total: 131€

We get the following allotments:

Allotment #1
Aquisição (Purchase): 01/01/2018, 50€
Realização (Sale): 01/04/2018, 65€
Despesas (Expenses): 1.5€
Allotment #2
Aquisição (Purchase): 01/03/2018, 70€
Realização (Sale): 01/04/2018, 65€
Despesas (Expenses): 1.5€

Dividends are registered in the table 8 (“Rendimentos de capitais”).

The columns of the table should be filled the following way:

• País da fonte – Country of the broker. “Países Baixos” for DeGiro. “Estados Unidos da América” for Interactive Brokers
• Rendimento bruto – total amount of received dividends
• Imposto pago no estrangeiro – leave blank because nothing was withheld abroad.
• Imposto retido em Portugal – leave blank because nothing was withheld in Portugal.

For each table you can indicate if you want to use the “englobamento” process for calculating your taxes. You can add both, a single, or no tables to that process.

Anexo G

Fill the “anexo G” if you have capital gains from shares held in a Portuguese broker. Usually these have tax withholding. You only need to fill this annex if you want to choose “englobamento” or if there wasn’t tax withholding.

This is a paper representation of the form which is equivalent to the version you find online. It has instructions on how to fill it.

Capital gains are registered in table 9 (“Alienação onerosa de partes sociais e outros valores mobiliários”).

The columns of the table should be filled the following way:

• NIF da entidade emitente – Fiscal identifier (NIF) of the broker/bank
• Código da operação – G01 (Alienação onerosa de ações)
• Realização – date and amount of sale
• Aquisição – date and amount of purchase
• Despesas e encargos – broker commissions of purchase/sale

A line should be added for each traded allotment. Read the section on “Anexo J” if you need to learn more about how to assess your allotments.

After filling the table you need to indicate if you want to choose “Englobamento”.

Anexo E

Fill “anexo E” if you have dividends from shares held in a Portuguese broker. Usually these have tax withholding. You only need to fill this annex if you want to choose “englobamento” or if there wasn’t tax withholding.

This is a paper representation of the form which is equivalent to the version you find online. It has instructions on how to fill it.

Dividends are registered in the table 4B (“Rendimentos obtidos em território português” / “Rendimentos sujeitos a taxas liberatórias”).

The columns of the table should be filled the following way:

• NIF da entidade devedora, registadora ou depositária – Fiscal identifier (NIF) of the broker/bank
• Código dos rendimentos – E10
• Rendimentos – net value of the dividend received (i.e. after taxes)
• Retenções na fonte – tax amount withheld.

After filling the table you need to indicate if you want to choose “Englobamento”.

Distributing and accumulating funds

Distributing funds distribute dividends to investors periodically. These funds usually do it every quarter but some do it every semester or year.

Alternatively, there are accumulating funds. These funds don’t distribute dividends to investors. Instead they use those dividends to reinvest within the fund. As a result the value of the shares increases.

In Portugal, accumulating funds are fiscally more advantageous than distributing funds whenever the investor wants to fully reinvest the dividends for a long period of time. With accumulating funds dividends are reinvested without leading to tax costs – this does not happen with distributing funds. In accumulating funds, dividends are translated into capital gains which are only taxed when the shares are sold. For these scenarios, investing in accumulating funds is recommended.

Example: Distributing fund

Share value: 10.000€
Dividends: 200€
Dividend tax: 56€

Example: Accumulating fund

Initial share value: 10.000€
Final share value: 10.200 € (because of dividends being reinvested)
Dividends: 0€.
Dividend tax: 0

Learn more about accumulating and distributing funds in my article: Should I choose accumulating or distributing funds? .

Keep yourself informed

I recommend you check if there are fiscal changes every year.

Multiple sites publish fiscal guides for every fiscal year. I recommend the fiscal guides from Deloitte, PwC and RCA. Deco also has good articles (example).

Planos Poupança e Reforma (PPRs) – private retirement saving funds

PPRs allow you to save for retirement with fiscal benefits. This type of product is similar to the 401(k) or IRA in the USA. Yet the implementation is very different than the 401(k).

PPRs are usually offered by insurance companies and investment banks.

Type of PPR

Not all PPRs are created equal even though they may share the same name. These products can take many legal forms: investment funds, retirement pension funds, life insurance funds.

The type of PPR affects the commissions, the entity that manages it, the entity that regulates it and the securities in which it invests.

Securities

At the moment, I don’t know any PPR that has a purely passive investment strategy. Technically, most PPRs are actively managed funds. Maybe in the future, “passive investment PPRs” will be created.

Even though, PPRs are active funds they may include ETFs in their portfolio. An example is the Alves Ribeiro PPR which currently holds 6.9% of its portfolio in the iShares STOXX Europe 50 ETF.

Often terms like “aggressive” or “conservative” are used to describe a PPR’s investment policy as well as the percentage of shares/bonds.

Like any other investment fund, the higher the exposure to assets with higher risk (e.g. shares) the higher the potential return of the fund.

Guaranteed capital

Guaranteed capital means that the investor will receive at least all capital deposited in a PPR. This is common in insurance PPRs. Uncommon in retirement pension fund PPRs. And unheard-of in investment fund PPRs.

Guaranteed return

Guaranteed return is common in insurance PPRs. Uncommon in retirement pension fund PPRs. And unheard of in investment fund PPRs.

Sales commission

The investor pays a commission when they acquire a PPR. Not all PPRs charge this commission. The commission may change depending on the broker used to acquire the PPR.

Withdrawal commission

The investor pays a commission when they withdraw their capital from the PPR.

Total Expense Ratio (TER)

The investor pays an annual commission based on the total capital invested.

Costs

The majority of PPRs I have found have commissions which are higher than my preferred ETFs. However, a fair comparison requires looking at all costs.

Brokerages charge transaction fees for buying/selling ETFs. PPRs typically don’t charge fees when customers contribute (usually through direct debit). This has a significant impact when investing lower amounts.

Additionally you need to keep in mind that PPRs have fiscal benefits while investing through ETFs does not. Reducing taxes is equivalent to reducing costs. For example, an hypothetical annual investment of €10,000 for 30 years at a net return of 6% grows to €790,581.86. If this investment were an ETF, in order to fully withdraw it, we would get €653,218.94 (after paying 28% in capital gains taxes). If this investment were a PPR, in order to fully withdraw it, we would get €751,335.31 (after paying 8% in capital gains taxes).

Fiscal benefits

The fiscal benefits can be translated into tax deductions and reduced tax rates.

Tax Deductions

You can deduct up to 20% of the total amount invested from the IRS gross tax amount. The maximum deduction varies with age:

• less than 35 years – maximum deduction: 400€. Amount necessary to get maximum deduction: 2000€.
• 35 years to 50 years – maximum deduction: 350€. Amount necessary to get maximum deduction: 1750€.
• more than 50 years – maximum deduction: 300€. Amount necessary to get maximum deduction: 1500€.

Note that there is a ceiling to the total amount of deductions you can make from your gross tax amount. The deductions includes health, education, PPR expenses, etc. The maximum you can deduct varies with the taxable income.

You can look at this deduction as a virtual capital gain. Imagine that you invested 2000€ and were able to deduct 400€, effectively you only paid 1600€ for 2000€ and had a capital gain of 25%.

Taxes

Qualifying withdrawals

When withdrawing up to 40% of the income is taxed (i.e. dividends and capital gains). The tax rate is 20% (effective tax rate: 8%).

This reduced tax rate only applies to the following qualifying withdrawals:

• 5 years after the first contribution
  • When the investor is older than 60
  • Retirement
  • When paying the home mortgage
• Without a contribution duration requirement
  • Long term unemployment
  • Disability
  • Death

Non qualifying withdrawals

These happen when the PPR one withdraws the PPR early. In these cases the tax rate is 21.5%. This tax is applied to a percentage of the gains according to the “age” of the PPR contract:

• less than 5 years – the whole income is taxed (effective tax rate 21.5%)
• between 5 and 8 years – 80% of the income is taxed (effective tax rate 17.2%)
• more than 8 years – 40% of the income is taxed (effective tax rate is 8.6%)

Note that there are fiscal penalties for doing non-qualifying withdrawals while having done a tax deduction of the contributed amount. In these cases, all the benefits from the deduction need to be returned with a penalty of 10% for each year until the date of the withdrawal.

Summary

Here you can find a spreadsheet which summarizes the findings of this article for a quick look.

Disclaimer: This information is for educational and entertainment purposes only. This does not represent, in any case, specific investment, legal nor tax advice nor recommendations to purchase a particular financial product. Learn more at https://indexfundinvestor.eu/disclaimers/