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What is Dividend Reinvestment Plan?

written by: Tim Plaehn•edited by: Rebecca Scudder•updated: 6/29/2011

A dividend reinvestment program is an investment option offered by a company whereby instead of receiving dividends as cash payment it will be reinvested in the company for stock purchases.

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    A Dividend Reinvestment Plan (DIRP) is an investment plan offered by a company to its existing sharehlders. The investor, instead of receiving dividend payments in cash, can choose to have the dividend amount directly reinvested in the company. Companies offer Dividend Reinvestment Plan to encourage the shareholders to buy stock directly from the company in lieu of dividend payment.

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    Types of DRIP

    There are three different types of DRIPs - DRIP directly run by the concerned companies, DRP through transfer agents and DRP arranged by brokers.

    Many companies directly organize DRIPs on their own without any external support in a bid to build healthy shareholder relationship. These DRPs can be bought directly from the company – sometimes even by persons not holding a single share of the company.

    Then there are the transfer agent-run DRIPs. Many companies find managing DRPs far too tedious and opt for outsourcing the work to Transfer Agents. Most transfer agents are well-known financial institutions that manage DRP programs for several client companies.

    Some brokerage firms assist shareholders to reinvest dividends earned even companies that do not have a formal DRP program. The only limitation to broker-run DRPs is it can apply to dividends alone and not open cash purchases which are referred to as optional cash purchases.

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    Salient features of DRIP investment

    Enrolling in a DRIP scheme of a company is quite simple and can even be done online. Once an investor enrolls, the dividend amounts get automatically reinvested in the company without any further reference. A redeeming feature of several DRIPs is they facilitate a purchase plan with direct stocks. This further helps in steady transaction procedures of buying additional stock shares by allowing the stock amount to be debited directly from investor's bank account. Purchases through dividend reinvestment programs generally attract no commission payment.

    Further, DRP permits purchasing even fractional shares by the investor. If an investor is patient and willing to bide time, this can steadily enlarge wealth in the investor’s bank account. But flexibilities and restrictions come together. Through DRIP, an investor has no option but to get dividend for a few discrete shares.

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    Few negative aspects

    Even if the investor is enrolled in DRIP and does not receive cash payments, the investor is still obliged to pay the applicable tax on the dividend income. The tax authorities are not particularly concerned whether the dividend is received as cash or reinvested in the company. While some DRIPs are offered free of charge, quite a lot of them entail payment of commissions.

    As DRIP is more in the nature of equity shares, the investor may enjoy profits when the company’s share prices rise but will lose whenever the company share prces decline. Another downside of DRP is the investor must keep track and maintain records of the purchases. This is necessary to know all about all the calculation procedures of capital gains tax for the shares sold by the investor.

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    Summing up

    There is no denying that DRP investment can be a profitable proposition in the long run. One can even start investing with small sums of money and then keep investing as frequently as one has spare money and also reinvesting dividends. DRIP is the ideal investment route particularly for people with modest income who also have the compelling necessity to save money for future needs.