Dividend reinvestment plans: Should you participate?
29 May 2015
By Shadforth Financial Group
Dividend reinvestment plans (DRPs) allow shareholders to reinvest the money they would ordinarily receive as dividends into additional company shares.
No brokerage or other fees are payable on the new shares issued under the DRP, with some companies even offering the shares at a small discount to the current market price.
For taxation purposes, if you participate in a DRP you are treated as if you had received a cash dividend and then used the cash to buy additional shares. You therefore have to pay income tax on the dividend, with the cost base of the new share issued under the DRP being the cost at which the shares were issued.
While DRPs are a cost effective way to increase your holding in a company, there are a number of issues to consider before participating.
1. Record keeping
A major issue is the record keeping requirements for capital gains tax purposes. Most companies pay dividends twice per year. Over a ten year period this equates to 20 purchases of shares – and this is just for one company.
2. Investment view
Automatically reinvesting dividends into the issuing company's shares may not always make sense from an investment point of view. This is because the company's share price may be expensive versus its peers or there may be better opportunities elsewhere in the market. The cost effective means of investing may therefore cost you more in opportunity cost.
3. Overweight holdings
Not every company offers a DRP to shareholders. This could mean those companies that offer DRPs become overweight in your portfolio, increasing portfolio risk.
4. Income in retirement
DRPs do not make sense for retirees who are seeking to generate an income from their portfolio, as the cash dividends are reinvested into additional shares.
Whist we recommend excess dividends should be reinvested back into the share market to maximise the benefits of compounding, DRPs are not always the best solution.