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Q I’m new to the DRIP world. What’s the difference between what you call No-Load Stocks™ and dividend reinvestment plans?
A An easy way to answer your question is by saying that all No-Load Stock™ plans are DRIPs, but not all DRIPs are no-load stocks.
More than 600 companies offer dividend reinvestment plans. These plans allow investors to buy shares directly from companies. Shares are purchased with dividends that the company reinvests for participants. In addition, most DRIPs permit optional cash investments that participants send directly to companies to purchase additional shares. The one catch is that in most DRIPs, an investor already must be a shareholder of record of the company in order to participate in the plan.
No-load stocks differ from other DRIPs in that no-load stock plans permit investors to make their initial purchase of stock directly from the company. No-load stock plans come in two varieties — plans that are open to all investors and "limited" no-load stock plans that are available only to certain investors, usually customers of the corporation or residents in the state or states in which the company operates. Thus, the main distinction between a simple DRIP and a no-load stock plan is that the former requires you to already be a shareholder in order to participate; the latter permits investors to make their initial purchase directly from the company.
Another distinction is that certain ancillary services, such as IRA options, automatic investment services, weekly and even daily stock purchases, and telephone redemptions, are available much more frequently in no-load stock plans than in basic dividend reinvestment plans.
The number of no-load stock plans now stands at more than 600, that’s up from 52 at the end of 1994.
Q I currently have a large investment with a brokerage firm, and I am very dissatisfied. I want to change to DRIPs, but I don’t know what to do. Can you help?
A In order to transfer your brokerage stock to DRIPs, you need to understand the following:
Not all companies offer DRIPs. Make sure your stocks have company-sponsored DRIPs. You can check by calling the firm’s shareholder services department.
In order to enroll in company-sponsored DRIPs, you must have the stock registered in your own name. If you have an account at a brokerage firm, and the broker is holding the stock certificates, you now have the shares registered in "street" name. In order to be eligible to join DRIPs, you must tell your broker to re-register the shares in your name. The broker will tell you that’s a bad idea — brokers like to hold shares in street name since it gives them control of the asset — but you need to have the stock registered in your name in order to join DRIPs. Unfortunately, your broker will probably charge you a fee to re-register the shares.
Once the stock is registered in your name, you’ll receive the stock certificates in your mailbox. Most DRIPs offer safekeeping services. When you join the DRIP, you’ll probably be able to send the stock certificates to the company if you don’t want to hold them.
Q I am considering DRIPs as an investment, but I’m worried about always having to add money. How often do I have to add more shares to the plan? Can I add a few shares and stop for a few months before adding more?
A I receive this question a lot, especially from newcomers to DRIPs. One of the beauties of DRIPs is that the plans are incredibly flexible. Most plans allow investors to purchase additional shares monthly or weekly. However, these "optional cash investments" are just that — optional. You are under no obligation to make monthly or weekly purchases. To be sure, some DRIPs may require the ownership of, say, five or 10 shares to remain in the plan. However, you are under no obligation to buy stock on a regular basis in these plans. Of course, the power of dividend reinvestment plans is the ability to make regular investments with relatively little money. Still, you are under no obligation to do so. One exception is if you decide to sign up for automatic investment services in a dividend reinvestment plan. Many DRIPs allow investors to make regular investments via automatic debit of a bank account. In these instances, investors are obligated to invest on a monthly basis. However, if you join an automatic investment service and decide, over time, you do not want to maintain regular investments, you can bow out of the service providing you’ve met the minimum investment required by the DRIP.
Q If I invest $10 or $50 per month in a company’s dividend reinvestment plan, what do I get for my money? Does the company hold my money until I can buy a full share of stock?
A The beauty of dividend reinvestment plans is that your money buys both full and fractional shares. If you invest $10 in a stock that trades for $50 per share, the DRIP will buy you 0.20 share of stock. Your money is invested in the stock, not held until you have enough to buy a full share. Thus, all of your money is working for you right away in dividend reinvestment plans.
Q I’m a novice investor with about $1,000 to invest. Am I better off opening an account with a brokerage firm or should I invest in DRIPs?
A I think you are probably better off buying a few DRIPs directly. One reason I prefer DRIPs to a brokerage account for newcomers is that money at a broker, especially an online broker, may tempt you to trade too often. And if you trade even just once a week, you’ll see your $1,000 erode quickly. It is not easy to trade stocks with DRIPs. Thus, your money will stay put and grow for you.
Q If I hold dividend reinvestment plans in an Individual Retirement Account, do I have to reinvest dividends?
A You cannot take distributions from an IRA without incurring at least taxes on the distributions and penalties if you are younger than age 59½. Thus, if you take receipt of dividends from DRIP IRAs, that would be considered a distribution for tax purposes. Now, let’s say you have DRIPs in an IRA that is being administered by a trust company. If the trust company offers a money market account within an IRA, it might be able to place the dividends within the money market account instead of reinvesting them in the stock. Keep in mind that the dividends are still held in an IRA (the IRA money market account), so you still won’t be able to receive them without incurring taxes and possibly a penalty. Bottom line: Make sure you reinvest dividends on DRIPs held in IRAs.
Q One of the problems I see with investing in dividend reinvestment plans is that you don’t have precise control over the buy and sell price. To me, this is a big deal. What do you think?
A I would agree that you don’t have the control over the buy and sell price through dividend reinvestment plans that you have investing with a broker. Fortunately, the situation is improving in the DRIP world. Many dividend reinvestment plans now purchase shares weekly or even daily, when practical. This is a far cry from the quarterly or monthly buying patterns of most DRIPs five or 10 years ago. Also, a number of dividend reinvestment plans now permit DRIP investors to sell their shares on a daily basis via the telephone. This has greatly improved the transaction speed on the sell side.
Quite frankly, the fact that I don’t have precise control over the buy and sell price doesn’t bother me. I figure that, over time, I’m just as apt to buy shares at a more favorable price than I am to pay a higher price. And since I sell so infrequently, the fact that I cannot sell shares now doesn’t concern me. In fact, I think one of the things that gets investors into trouble is that it is too easy to buy and sell stocks these days, especially with the advent of online trading. I think too many investors trade stocks simply because they can, rather than because they should. I also think that having precise control over the buy and sell price may cause you to try to "micro" time purchases and sells. I can’t tell you how many times I’ve seen investors fail to buy a stock simply because the stock never fell to that investor’s "buy" price. If you try to finesse the purchase price too much, oftentimes you’ll never buy the stock because it rallies away from your target price. Don’t worry so much that you cannot buy stock in dividend reinvestment plans at a precise price. If it’s a good stock and you’re investing for the long term, it shouldn’t matter.
Q What is the best way to sell stocks from a dividend reinvestment plan?
A This is a timely question since I recently sold one of my dividend reinvestment plans. Most DRIPs allow investors to sell stock directly from the plans. Companies may require DRIP participants to notify the plan in writing with their sell instructions. However, a number of companies allow DRIP participants to sell their shares via the telephone.
Here are the steps I followed:
Before I sold my DRIP shares, I first had to clear up a potential problem. When I purchased the initial shares I needed to join the DRIP, the broker sent me the stock certificate representing those initial shares. Once I joined the DRIP, I was reinvesting the dividends on all my shares, both the shares I held in the plan as well as shares I held in certificate form. If I called to sell my DRIP shares, however, the firm would have sold the shares held in the plan but wouldn’t have sold the shares I held in certificate form. Thus, I would have been stuck trying to sell the five shares I held, which would have been more costly and less convenient. Thus, before I sold my shares, I sent my stock certificate representing five shares to the company to hold for me in book-entry form in the DRIP. After obtaining the mailing address from the transfer agent, I sent the certificate via registered mail.
Once all of my shares were held by the company, I called the toll-free number provided by the company’s transfer agent. I gave the instructions to sell all of my DRIP shares.
It will take a few weeks to receive the sale proceeds.
As you can see, selling through the company may take some time. If you are concerned about speed on the sell side, make sure your DRIP is holding all of your shares. Also, an alternative to selling through the plan is to sell your DRIP shares through a broker. To sell through a broker, you’ll need to have the transfer agent send you a certificate representing all of the shares you own in the DRIP. Once you have the stock certificate, you may go to a broker and sell the shares immediately. Keep in mind it may cost you more to sell through a broker than through the dividend reinvestment program.
Q What are some of the tax implications of investing in DRIPs?
A Concerning DRIPs and taxes, there are a few key things to remember:
Even though dividends are being reinvested, they count as ordinary income for tax purposes. Therefore, remember to include reinvested dividends as part of your income. Companies will send you 1099 forms at the end of the year showing how much was paid in dividends.
It is important to keep track of the stock price each time you make purchases in a DRIP. This cost basis will come into play when you sell stock and have to determine your cost basis for tax purposes. If you can identify the shares of stock sold, your cost basis is the cost of those particular shares of stocks. However, if you sell securities at various times and cannot identify the shares that are sold, the cost basis of the securities sold is the cost of the securities acquired first — the "first-in, first out" method.
You must report as income any service charges paid on your behalf by the company, although you can deduct these charges in the year they are paid as a miscellaneous deduction if you itemize.
If you purchase shares at a discount, you must report as income the difference between the cash you invest and the fair market value (full value) of the stock you buy.
Q What happens to my DRIPs when I die?
A As is the case with any securities or other assets, presumably you distribute the DRIPs via your will. Heirs to the DRIPs need to go through the transfer agent of the DRIP companies in order to change the registration. One benefit for individuals who inherit stocks, including DRIPs, is that the cost basis for the securities is "stepped up" to the price at the time the stock is inherited. Thus, let’s say your grandfather was fortunate enough to buy McDonald’s in the ’60s and accrued huge capital gains during that time. If he leaves McDonald’s stock to you, your new cost basis which comes into play for tax purposes when shares are sold, is the price on the date of his death.
Q I’m interested in getting my grandson started in DRIPs. How can I go about giving him DRIPs as a holiday gift?
A It’s becoming more common for parents and grandparents to forgo the music CDs and video games to purchase gifts of stock for their children and grandchildren.
It’s very easy to give the gift of DRIPs. One way is by transferring some shares you may have in a DRIP to another party. This is the easiest and quickest way to enroll someone in a DRIP.
The process of transferring shares is relatively simple, although it may differ slightly depending on the company and its transfer agent. Generally speaking, individuals who want to transfer shares need to obtain a "stock power" form from a brokerage firm or bank that conducts transfers. Fill out the "stock power" form and include the name, address, and social security number of the individual to whom you are transferring the shares. You must have a "medallion" signature guarantee on the stock power. This guarantee is usually available at a bank or brokerage firm. When you have completed the form and obtained a "medallion" signature guarantee, return the form to the company or its transfer agent. You might want to include a letter stating your intentions and specifying that you would like to enroll the individual directly into the DRIP. Most companies will oblige. If the transfer agent does not enroll the party directly into the plan, the individual will receive a stock certificate and, in most cases, a DRIP enrollment form. The individual who is receiving the transferred shares will need to fill out the enrollment form and return it to the company. Once the company receives the enrollment form, the individual can usually start investing directly in the DRIP.
If you do not own stock in a company in which you want to give shares as a gift, check to see if the firm has a "gift-giving" feature in its DRIP. A number of no-load stock plans offer this feature. I have opened "gift" accounts for my parents and found the process very easy.
If you set up an account for a child, consider setting up a Uniform Transfer to Minors Account (UTMA). Funds in the account are in the minor’s name and social security number and are considered to be owned by the minor. Dividends paid on the account are taxable, most likely at a preferred tax rate. The adult custodian is responsible for the account until the minor reaches the age of majority. Any withdrawals from the account are payable to the custodian on the minor’s behalf until that time. If you are interested in creating a UTMA, contact the company’s shareholder services department for the proper forms.
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Life In Financials
Charles Carlson, CFA
Editor, DRIP Investor
One group that I believe will lead the market in the near term is the financial sector . . .
This directory covers over 600 dividend reinvestment plans, including the ones that can be purchased directly from the company.
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