A dividend reinvestment plan (DRIP) allows shareholders to reinvest their dividends in additional stock rather than receiving them in cash. These plans are offered directly by companies or through agents acting on behalf of the corporation. In the former case, a company issues new shares in lieu of a cash dividend.
You also have the option of purchasing additional shares from the company. The advantage is that you pay no brokerage fees, although some companies charge fees for this service. The other type of plan is offered by agents, such as banks, that collect the dividends and offer additional shares to shareholders who sign up for the plan. The bank pools the cash from dividends and purchases the stock in the secondary market. Investors are assessed fees that cover the brokerage commissions and the fee charged by the bank.
Advantage of DRIPs
The advantage of DRIPs to shareholders is that they act as a forced savings plan; dividends are reinvested automatically to accumulate more shares. This method is particularly good for investors who are not disciplined savers.
Disadvantage of DRIPs
A disadvantage of dividend re-investment plans is that shareholders need to keep, for tax purposes, accurate records of the additional shares purchased. When additional shares are sold, the purchase price is used to determine whether there is a capital gain or loss.
These dividends are considered taxable income whether they are received in cash or reinvested automatically in additional shares. Another disadvantage of DRIPs is that the fees charged to participate in the program can be high.