Tuesday, November 6, 2012

What Is A Dividend Reinvestment Plan?

Dividend reinvestment plans (or DRPs) offer investors a way to gradually increase their stake in a company.  Instead of receiving a cash dividend payment, investors receive an equivalent amount in the form of new shares in the company.

You Don't Have To Participate

Dividend reinvestment plans are voluntary.  By default you will not participate in the DRP and will instead receive all of your dividends in cash.

If you would like to participate in a company's DRP, you will need to notify the company.  They will normally send out the forms not long after you buy your initial shares in the company, or in the lead up to a dividend payment.

In addition, most plans allow you to receive only part of your dividend payment in the form of shares with the balance received as cash, if that is something you're interested in.

Cost Effective

One of the main benefits of dividend reinvestment plans is that there's no brokerage fees payable.   This means that you can grow your investment in a particular stock gradually over time without paying any commissions.

Another benefit with some plans is that they issue the new shares at a discount to the current share price.  Discounts are normally around 2.5% or 5%.

An Example

Let's look at a real world example.  Woolworths (ASX:WOW) most recent dividend payment allowed investors to reinvest their dividends at a price of $28.882297 per share.  The amount of the dividend (per share) was 67 cents.

If you held 300 Woolworths shares at the time the dividend was paid, you would be entitled to 6 new Woolies shares.  How does it work?
  • Total dividend paid:  $201
    This is the total amount of the dividend to which you are entitled (300 shares by 67 cents).
  • Shares issued:  6
    This is the number of new shares to which you are entitled under the DRP ($201 divided by $28.882297, rounded down).
  • Total cost of new shares:  $173.29
    This is how much the new shares cost.
  • Amount carried forward:  $27.71
    This amount is held by the company and is added to the dividend amount used in the next issue of shares under the DRP.
The "Amount carried forward" figure above may need some explanation.  Dividend reinvestment plans only operate in whole numbers of shares.  Since the cost of the shares issued almost never matches the amount of the dividend, the leftover amount is held by the company to be used for the next dividend.

Tax Implications

Even though you don't actually receive the dividends in cash, you still need to include them on your tax return as income.  You are also entitled to and franking credits.  (Please note, this is just my understanding how Australian tax law operates with regard to dividend reinvestment plans.  However I'm not a qualified tax professional so make sure you get your own advice.)


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