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DRIPs: A commission-free way of building your retirement nest egg

by Wayne Cheveldayoff, 2003-08-30

One of the key advantages of dividend reinvestment plans, or DRIPs, is that participating investors donít have to pay brokerage commissions on the additional stock investments they make. Under such plans, dividends are automatically reinvested into new shares without any transaction costs.

While the saving in brokerage commissions may seem small at first, every little bit helps when you are building a retirement nest egg. The longer the investment is held, the more the benefit would compound.

Not all dividend-paying companies in Canada have a DRIP. But more than 40 blue-chip Canadian companies do, including all of the major banks and many of the better known names listed on the Toronto Stock Exchange, such as Molson, Noranda, TransCanada Pipelines and BCE.

At least 45 income trusts also offer DRIPs (in this case, distribution reinvestment plans). The list includes many of the popular real estate investment trusts (REITs) and oil and gas royalty trusts.

The best way of knowing if a company or trust has a DRIP is to check its website or send an email inquiry to an address listed on the site.

You can usually start a DRIP program with as little as one share or trust unit registered in your name. All it takes is filling out a form.

Once you are in the program, your dividends (or distributions) will be automatically invested in shares (or trust units) and you will receive regular statements.

The reinvestments are usually made at the prevailing market price, although, in a few cases, the reinvestment is undertaken at a discount of between 2 and 5 per cent to the market price. Such discounts are offered by the Toronto-Dominion Bank (2.5 per cent), Telus (3 per cent), Pembina Pipeline Income Trust (5 per cent) and Enerplus Resources Fund (5 per cent), among others.

Companies and trusts offer these discounts as a way of building a loyal shareholder base. Also, while not the main reason, raising capital in this way is usually cheaper than the 8 per cent or more in dealer commissions it costs companies and trusts to raise funds via the public markets.

About half of the DRIPs offer investors the option of putting in more cash to buy more shares or trust units--also without having to pay brokerage commissions. These cash investment options range from a little as $3,000 annually to as much as $350,000 a year. BCE, for example, limits such cash investments to $20,000 a year. Inco limits them to $56,000 a year and Riocan REIT and Canadian REIT each apply limits of $25,000 a year.

While DRIPs offer tangible benefits, investors also face significant paperwork.

For tax purposes, DRIP participants would be wise to keep a complete set of records for all reinvestments as long as they continue to own the shares or trust units. The only exception would be for shares or units held in registered plans, such as RRSPs, RRIFs and RESPs.

Outside of such registered plans, there is no special tax treatment for DRIPs. Dividends or distributions reinvested in a year must be recorded on your tax return for that year as if they were received in the normal way. Thus, they will be taxed like any other dividends.

When the shares are sold and it comes time to calculate the capital gain (or loss) for tax purposes, all stock purchases through reinvestments will have to be known and accounted for. The reinvestments are added to the original investment to determine the total cost of the holding.

For reinvested distributions, it could get fairly complicated, as these may be split in any given year, depending on the trust, into taxable income, dividends and return of capital.

Return of capital is not immediately taxable but is eventually taxed as a capital gain because it reduces the adjusted cost base of the investment from which the capital gain is calculated. However, when the trust units are sold, the total amount of distributions that were reinvested would be added to the adjusted cost base to determine the total cost of the holding. Given the complexity, it would be best for investors in this position to consult an accountant.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.

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©2003 Wayne Cheveldayoff