What is a Dividend Reinvestment Plan?
A Dividend Reinvestment Plan, also known as DRP or DRIP, is a scheme or program that gives existing shareholders the option to acquire additional shares in a company instead of being paid a dividend. The Dividend Reinvestment Plan is not compulsory, and shareholders can volunteer to increase their stakes in the company without dipping into their own pockets.
Should dividends be reinvested and is Dividend Reinvestment a good idea?
One of the easiest ways to save money when investing is by participating in a Dividend Reinvestment Plan. Dividend reinvestment can be a good idea for investors who want more shares in a company but do not want to pay for them out of pocket.
How to set up a Dividend Reinvestment Plan?
Joining or setting up a Dividend Reinvestment Plan is seamless and effortless. By default dividends will be sent to your nominated bank account however if the company with whom you have shares offers a Dividend Reinvestment Plan then you can sign up to reinvest your dividends.. Set up a Dividend Reinvestment Plan by completing an electronic Dividend Mandate Form with your broker. This form authorizes the company to reinvest your dividends instead of sending cash to your bank account.
How does a Dividend Reinvestment Plan work?
Not all companies pay a dividend but those who do, decide how often and how much dividend is to be paid to their shareholders. Companies that pay dividends can pay those dividends in two ways – as a Cash Payment or as additional shares in the company under a Dividend Reinvestment Plan.
Cash Payments
This is the simplest way to receive an income from your shareholding. When a company declares a dividend, the total amount is simply sent to your bank account.
For example, if you own 100 shares in the company NAB and they pay a dividend of $0.20 per share you would receive $20 (100 shares* $0.20) in your bank account.
Dividend Reinvestment Plan
Under a Dividend Reinvestment Plan, when a company declares a dividend, instead of receiving cash in your bank account you receive additional shares in that company. The company will decide on the price that the additional shares will costs and use your dividend payment to allocate those new shares.
For example, if you own 100 shares in the company NAB and they pay a dividend of $0.20 per share you would be entitled to $20 (100 shares* $0.20). However, if under a Dividend Reinvestment Plan the company decides that each additional share is worth $2.00 then at this price you would be entitled to 10 additional shares ($20/$2 per share).
The Good, the Bad and the Ugly of Dividend Reinvestment Plans
The Good
Dividend Reinvestment Plans give existing shareholders the option of acquiring additional shares in a company without having to pay out of pocket.
Dividend Reinvestment Plans benefit shareholders because it eliminates the charge of a transaction fee when acquiring additional shares in a company.
Under Dividend Reinvestment Plans, companies may provide additional shares to its shareholders at a discounted price.
The Bad
Dividend Reinvestment Plans may cause dilution of or a reduction in the total dividend per share distributed by a company because there will be an increase in the number of shares on issue.
For example, the company Telstra has 100,000 shares on issue and a total dividend of $20,000 to be distributed.
Before Dividend Reinvestment Plan - Each share will attract a dividend of $0.20 ($20,000 total dividend / 100,000 shares).
After Dividend Reinvestment Plan - If the company increases its shares on issue by 10,000 shares, each share will attract a dividend of $0.18 ($20,000 total dividend / 110,000 shares).
The Ugly
Dividend Reinvestment Plans have tax implications.
Although no cash is exchanged for the dividend, and there isn't a specific Dividend Reinvestment Tax, the transaction is still classified as an income to shareholders for tax purposes.
As additional shares are acquired, shareholders will need to keep track of the cost of the shares acquired under a DRP. Upon selling the shares, shareholders will have to account for capital gains/losses (selling price - purchase cost) for tax purposes.
Final word
Dividend Reinvestment Plans can save you money. It is a steady way to increase your shareholdings in a company without having to pay any money out of your own pocket. The process is seamless and requires no action on the shareholders other than joining the program. It eliminates transaction fees when acquiring additional shares and shareholders may get these shares at a discounted price. However, beware of dividend dilution, be mindful of the tax implications and seek professional advice when needed. With all this information at hand, get your budget in order, Start investing today and join a Dividend Reinvestment Plan.
NB. The information contained in this article is for informational purposes only and is not intended to be financial advice.