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DRIPs help investors build their savings

by Wayne Cheveldayoff, 2006-12-06

Dividend or distribution reinvestment plans, known as DRIPs, give investors an edge in building their retirement savings.

DRIPs allow investors to automatically reinvest dividends from companies or distributions from income trusts into additional shares or units without any transactions costs.

This is a benefit that can really add up to a significant amount if you are intending to reinvest on a monthly or quarterly basis. Without having to pay commissions, your savings can compound at a more rapid rate.

In addition to not charging any fees, a few companies and trusts offering DRIPs, particularly royalty trusts in the energy sector, price the additional shares or units at discounts ranging from 3 to 6 per cent – another important benefit.

For example, Pengrowth Energy Trust offers a 5-per-cent discount, while Paramount Energy Trust’s discount is 6 per cent. However, most blue-chip dividend-payers don’t offer discounts.

DRIPs effectively encourage investors to follow a widely recommended investment technique – dollar-cost averaging. By buying shares on a regular basis, you will be able to catch the dips in the share or unit price and hopefully end up with a lower average cost than if you make your investment all at once.

Not all dividend or distribution-paying entities in Canada have a DRIP. But more than 40 blue-chip companies do, including all the major banks and many of the better known names listed on the Toronto Stock Exchange, such as TransCanada, Canadian Tire, Imperial Oil, Magna, Manulife, Sun Life, BCE, Telus, Suncor and Thomson.

At least 110 income trusts also offer DRIPs. The list includes many of the popular real estate investment trusts (REITs), such as H&R REIT, and oil and gas royalty trusts, such as Batex, Shiningbank and Harvest.

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.

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

Companies and trusts offer DRIPs (and sometimes 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 them to raise funds via share or bond issues in the public markets.

Close to 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 as little as $3,000 annually to as much as $350,000 per year. BCE, for example, limits such cash investments to $20,000 a year, but Manulife allows up to $250,000 in a single year.

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

For tax purposes, DRIP participants would need 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.

When all the shares or units are sold and it comes time to calculate the capital gain (or loss) for tax purposes, all 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 effectively as a capital gain if the investment maintains its value.

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. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.



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©2006 Wayne Cheveldayoff