Posted by Elliot Kravitz, ATP

Reinvested Dividends

Reinvested Dividends

One of the most popular forms of investment is dividend investing. Dividends provide a smooth income stream to investors. You have two options when the dividend accumulates on a stock. You can take the money or reinvest the dividends in the same shares of the company.


How Are dividends Reinvested?

There are two main ways to reinvest. You can reinvent yourself, or most companies offer a dividend reinvestment plan (DRIP) option. Several shares of the same company are automatically acquired, with dividends reinvested in the company.

You can continue to deposit dividends into your account and buy multiple stocks for the same amount when you think the price is attractive. You may want to buy another bond with the dividends earned.

 

Should You Reinvest or Take the Money?

There are several forethought when deciding whether to receive money or reinvest dividends. If you decide to hold stocks for the long term, it usually makes sense to keep reinvesting in the dividends.

 DRIPs have many advantages, including:

• Free Transactions: you usually have to pay brokerage commissions to buy stocks. With DRIPs, dividends are automatically reinvested in shares.

• Fractions of shares: Normally, it is impossible to buy fractions of shares in the market. With DRIP, the stocks that your dividends can buy are automatically purchased from your account, which includes fractional shares. 

• Average Dollar Cost: Companies that run the DRIP typically apply Average Dollar Cost to determine the cost of stocks purchased with dividends reinvested, which avoids buying at peaks and troughs.

However, whether or not to reinvest dividends is a personal decision that depends on factors other than the prospect of profitability. The need for liquidity can be one of the factors that determine the decision. If you need the money, you might want to consider taking the cash.

Dividends reinvested options may not perform as expected or may not be on par with the rest of the portfolio. If this is the case, you can withdraw money from the stocks and invest where the hope of winning is highest. Additionally, you may want to broaden your portfolio. By withdrawing money from a particular stock's dividends, you can invest in another stock or asset. Diversification can help you balance your portfolio according to your choices and requirements.


Are Reinvested Dividends Taxed?

Reinvested dividends are taxed as cash dividends. There are cash dividends that are reinvested to buy more shares. In such cases, dividends may or may not qualify. If the dividend qualifies, it will be taxed as a capital gain, and the tax rate will depend on total taxable income. If the dividend is not eligible, it will be added to total income. You have to pay taxes on dividends at a marginal rate.

Reinvested dividends are taxed in the same way as cash dividends. These are cash dividends that are reinvested to buy more shares. In such cases, dividends may or may not qualify. If the dividend qualifies, it will be taxed as a capital gain, and the tax rate will depend on total taxable income. If the dividend is not eligible, it will be added to total income. You have to pay taxes on dividends at a marginal rate.


Tax On Eligible Dividends:

Eligible dividends, which must meet certain requirements, are subject to lower rates of capital gains tax active. There is a difference between unrealized and realized capital gains. You don't make a profit until the stock or other assets are sold.

Usually, taxes are not paid until a profit is made. However, there are exceptions to this rule.

The amount of tax paid on an eligible dividend depends on the income of the recipient. For those with 10-15% income, there is no tax on an eligible dividend as of 2020. This only applies if the dividend income does not exclude the beneficiary from that category tax. The tax rate for middle-income groups is 15%. For those in the 37% tax category, the tax rate on eligible dividends is 20%.


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