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    Low-Cost Investing: A Guide to Dividend Reinvestment Plans

    Low-Cost Investing: A Guide to Dividend Reinvestment Plans

    The attraction of dividend-paying stocks has increased now that dividends receive preferential tax treatment. Companies that offer dividend reinvestment plans—in particular those that will sell initial shares directly to the public—offer the added bonus of lower transaction costs.

    More than 750 companies in the U.S. offer dividend reinvestment plans to their shareholders, and almost half of those will sell even the initial shares directly to the public, which means you do not need to own any shares in order to join the plan. The concept is straightforward: Instead of sending participating investors cash dividends, the company applies those dividends to the purchase of additional company shares with little or no commissions levied.

    Of course, a number of major discount brokerage firms offer dividend reinvestment plans of their own, which allows you to reinvest the dividends of the stocks you own through the brokerage firm with no fees attached. This is an advantage because the amount of many dividend payments would otherwise typically entail the purchase of odd-lot sizes, which often have higher transaction charges.

    However, many corporate dividend reinvestment plans allow participants to make additional cash purchases of shares at little or no cost. And, companies that will sell their shares directly to the public—even if you are not a current shareholder—allow you to totally bypass a broker.

    Dividend reinvestment plans are custom-made for long-term, buy-and-hold investors. While they are not on their own a reason to buy a stock, they serve as a shareholder bonus on a company with promising long-term growth prospects.

    How Do You Join?

    Currently, around 300 companies will sell initial shares directly to investors so that no purchases need to be made through a broker, although most have minimum investment amounts. Minimums for direct purchase range from $10 to $2,000; a typical minimum is $250. In a very few cases, a firm may offer only a direct purchase plan without maintaining a dividend reinvestment plan if they do not pay a cash dividend. Table 1 lists the companies that offer direct initial investment, along with a contact phone number and initial investment minimum. Other dividend reinvestment plans require that you own at least one share (and sometimes more) registered in your name—you are a shareholder “of record.” That means your name appears on the corporate records as the owner of the shares rather than the nominee name (“street name”) of the broker or bank that may have purchased the shares for you (and who may be safekeeping them for you). If your shares are held in street name, you should ask your broker to transfer the shares to your own name.

    Usually, a company will send you a dividend reinvestmentplan prospectus or description and an authorization card once you become a registered shareholder. You can also call the company (ask for shareholder relations) or the dividend reinvestment plan agent and request these items.

    You should read the plan prospectus or description carefully. While the overall structure of most dividend reinvestment plans is similar, they vary in the details. The prospectus or description will provide information on such items as: eligibility requirements, plan options, costs, how and when purchases are made, how and when certificates will be issued, and how participants withdraw from the plan.

    Plan Mechanics

    Some companies have extensive investor relations departments that administer their own dividend reinvestment plans. Most companies, however, appoint an outside agent to serve as the administrator for the plan.

    The administrator maintains records, sends account statements to participants, furnishes certificates for shares upon request and liquidates participants’ shares when they leave the plan. The agent also is responsible for the purchase of company shares for the plan. When you join a plan, you will sign a card that authorizes the agent to make purchases on your behalf.

    Shares purchased under a dividend reinvestment plan are held by the plan and registered in the nominee name of the agent or plan trustee on behalf of the participants, each of whom has an account under the plan. For many participants, that means you will hold the company’s shares in two places—your original registered shares, with the certificates either held by you or in custody at a bank or brokerage firm, and the shares purchased through the dividend reinvestment plan, held by the plan.

    Many plans will allow participants to deposit certificates of shares registered in their own name into their dividend reinvestment plan account for safekeeping at no charge or for a modest fee; these shares are then treated in the same way as the other shares in the participant’s account.

    Certificates for shares purchased under the plan are usually issued only upon written request, although often at no charge. Certificates are also issued when a participant no longer wants to participate in the plan.

    Plan Options

    The basic plan offers reinvestment of dividends on all shares of stock registered in the participant’s name. This is often referred to as “full reinvestment.”

    Under most plans, it isn’t necessary to reinvest all dividends. Instead, participants are allowed to reinvest dividends on a portion of their registered shares while receiving cash dividends on the remaining shares. This is usually referred to as a “partial reinvestment option.” Most plans also allow participants to purchase additional shares by making cash payments directly to the plan. This option is often referred to as “optional cash payment,” and since the allowable amounts can be large, it offers participants a low-cost way to build a sizeable holding in a company. The payments are optional—participants are not committed to making periodic cash investments.

    However, usually there are minimums for each payment made, and often there is a maximum.

    It is also important to note the frequency with which the plan invests cash payments, since interest is not paid on payments received in advance of actual investment.

    A twist on the cash payment option is that some companies will allow registered shareholders to make cash investments without requiring them to reinvest dividends on the shares they are holding, although they may do so if they want. This is frequently referred to as the “cash payment only option.”

    An added convenience for participants who wish to make systematic cash investments is an automatic investment feature that is offered by about half of the companies. The company or the plan agent automatically debits theinvestor’s checking or savings account at regular intervals to purchase additional shares.

    The Costs

    Participant costs usually come in two forms: service charges and prorated brokerage commissions. Service charges cover administrative costs and are generally levied on each transaction; participants can hold costs down by combining a cash payment with a dividend reinvestment transaction, since usually the charges are capped (a $5.00 per transaction maximum is typical). Brokerage commissions levied on open market shares are at institutional rates (since the number of shares purchased is large), and are therefore considerably lower than the rate an investor would pay on his own.

    Many companies cover all of the costs for share purchases from both reinvested dividends and optional cash payments. Some companies levy service charges, others prorate brokerage costs, still others charge participants for both—there are many variations, so check the prospectus or plan description carefully.

    When participation is terminated, some dividend reinvestment plans will sell plan shares for you, if you prefer, instead of sending you certificates. The cost to the participant is usually any prorated brokerage commissions, a lower-cost alternative than selling through a broker. Some plans will sell plan shares for you even if you are not terminating. Check the prospectus or plan description.

    Share Purchases

    The source of share purchases under a dividend reinvestment plan is spelled out in the plan description and prospectus.

    The most common source is the secondary market—through an exchange where the shares are traded, in the over-the-counter market, or through negotiated transactions. Another source for some purchases is the company itself, using authorized but unissued shares of common stock or shares held in the company’s treasury.

    In plans that prorate brokerage commissions among participants, the source of share purchases is a concern. When shares are purchased directly from the company, there are no brokerage expenses to prorate.

    When shares are purchased directly from the company, the prospectus will describe how the share price is determined. Usually, it is based on an average of the high and low or the closing price for the stock as reported by a specified source.

    Some companies offer participants discounts on the share price, but there is wide variation in how this is offered. Most often, the discounts are available only on shares purchased with reinvested dividends, but sometimes discounts apply to shares purchased both with reinvested dividends and with cash payments. Discounts are described in detail in the plan’s prospectus.

    Taxes

    Dividend reinvestment plans have many advantages, but their tax status is not one of them—unless you are investing through an IRA (offered by a few companies). Whether you receive your dividends in cash or have them reinvested, a taxable event has occurred, although the tax treatment now is lower than it was previously. In addition, if you reinvest dividends, the IRS considers the “dividend” to be equal to the fair market value of shares acquired with reinvested dividends. The fair market price is the price on the exchange or market where shares are traded, not any discounted price. Furthermore, any brokerage commissions paid by the company in open market purchases are considered additional dividend income to the participant.

    When shares are sold, the tax basis is the fair market value as of the date the shares were acquired, plus any brokerage commissions paid by the company, and it is treated as income to the participant.

    Participants receive 1099-DIV forms each year from the company detailing dividends to be treated as income as reported to the IRS.

    Where to Find DRPs

    Listings of companies that maintain dividend reinvestment plans are readily available on the Internet. Most lists include basic information about enrollment and plan minimums.  


    This listing of companies that will sell their initial shares directly to the public was compiled by ShareBuilder Corp., a leading provider of on-line investment services. ShareBuilder (www.sharebuilder.com) enables customers to build automatic investment plans in the stocks, exchange-traded funds and close-end bond funds of their choice, with low transaction fees ($4 or less), as well as with no account minimums, no investment minimums and no inactivity fees.

    The company operates ShareBuilder Securities Corporation, a registered broker dealer and member NASD/SIPC. ShareBuilder, its on-line brokerage product, is the nation’s eighth largest on-line brokerage.