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Dividend Reinvestment Plans (DRIPs):
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Do I pay taxes on my dividends
with DRIPs?
Even though the you are
reinvesting the dividends received by a company, those payments
are still considered as income and
While the dividends
received by a corporation are taxable in the year they were paid,
the gain in share price of the stock is not taxable until it is
sold. This is called Capital gain, which is
generally taxed at a much lower tax rate if the shares are held
for long term (more than one year). Investing for the long-term
pays off because you can take profits in stock and pay less taxes. |
Many DRIPs will also buy back
shares at any time you want to sell, in most cases for a minimal sales
charge. Yet another good use of a DRIP is to give a small amount
of stock as a gift. You may not want to set up a brokerage account for
your son, but you may want to give her 5 shares of Disney. You can help
your son benefit from stock ownership with a DRIP account using a
Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) and
lets someone make additional purchases relatively easily.
There are over a thousand corporations which offer DRIPs. The list includes most well-known and respected companies,
including IBM, Coca-Cola, Fannie Mae, Charles Schwab, Sears and
McDonald's. The specifics of the DRIP plans vary as widely as the
corporations themselves. For example, some corporations allow investors
to make contributions as often as every week. While others only allow
stock purchases to be made on a quarterly basis.
In order to qualify for a DRIP plan you need to already
own a stock in the company you are interested in. If you don't already
own a stock in the company, the obvious step would be to take
ownership in the company. The easiest way to buy a stock is to open an
account with a broker and simply purchase stock. If the stock is
already owned, you must have the physical stock certificate
in your possession not in a street name.
If you do not, the certificate can be easily obtained from your broker
with which the stock is held or from the transfer agent. With the stock
certificate in hand, the next step is to open the DRIP account directly
with the company. The best way to learn more about the DRIP plan you're
interested in along with any share transfer requirements is to contact
the company you're interested investing in and request a prospectus
along with the appropriate DRIP account forms. These documents will
detail the specifics on the plan.
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Why would a company offer a DRIP?
You may be wondering why a huge corporation would concern itself with selling a
couple shares to the public direct. The company's advantage is that DRIPs offer
the company low-cost access to capital. When you purchase a stock on an exchange
you are buying it from another investor, so the company sees no benefit from the
sale. Where as with DRIPs, shares are bought directly from the company, and the
cash from you buying the shares are then reinvested into the company. Companies
also like DRIPs because they get a stable shareholder base that typically has a
long-term investment style. DRIP investors are very unlikely to sell their
shares when the markets start to turn sour, partly because selling DRIP shares
takes a little more time and effort than just calling a broker or trading
online.
How to Get Started
Many beginner direct investors make the mistake of thinking that just buying the
shares in a brokerage account will count toward setting up a DRIP.
Unfortunately, this is not the case. To start a DRIP you must have the shares
issued in your name. Most shares purchased though a broker are held "in street
name," which means your broker is listed as the owner. The Moneypaper (http://www.moneypaper.com)
for a flat fee of $30 will get you started in a DRIP with a list of 1000 or more
companies, and that's all you ever pay. Just remember that as an individual
investor dealing with DRIPs, you won't receive help from any brokers because
Wall Street has no interest in selling stock without commissions. If you wish to
use existing shares you own in a DRIP, you must either use a transfer agent, or
kindly ask your broker, who will typically charge you a fee for the service.
Transfer agents include the NAIC (http://www.better-investing.org/store/lcp.html)
and Moneypaper.
If you want to learn know more
on DRIPs and want to know which companies offer them, Read a book
called
Buying Stocks Without A Broker or go to these great
web sites.
DripAdvisor.com - This is a newsletter designed to empower the
individual investor through DRIPS.
Drip Investor - This is a monthly publication bringing you the latest
news on dividend reinvestment plans and no-load stocks and their many
commission-free investment options.
Motley Fool: Fool School: Drip Investing - Here there are tutorials
and articles explaining DRIPs.
Next-->> How to
place orders to buy and sell stocks
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