How to Reinvest Dividends & Taxes

Reinvested dividends help investors generate long-term wealth.

Total stock market returns include capital gains, alongside dividend income. Dividend payments may be spent to satisfy everyday budgeting needs, or reinvested back into financial markets. Reinvested dividends accelerate compounding, where total returns increase with larger investment principal amounts. Be advised that reinvested dividends introduce important tax considerations that affect your bottom line. Begin the wealth creation process with an assessment of your personal finances, before evaluating outside investment opportunities.

Things You'll Need

• Annual reports
• Banking statements
• Brokerage statements
• Credit statements
• 1099-DIV forms

Instructions

Reinvest Dividends

1. Analyze personal financial statements to evaluate your current finances. Ensure that cash is available to meet your living expenses. Beyond cash flow, review your current assets and debt obligations to make note of investment returns and interest expenses.

2. Contact investor relations departments for dividend payment amounts and scheduling. You must buy and hold shares before and through their ex-dividend date to receive dividends on the payable date. Ex-dividend and dividend payable dates are generally one month apart.

3. Read corporate annual reports to analyze new investment possibilities. You may elect to purchase assets with better opportunities for growth than your current portfolio holdings. If not, plan to reinvest dividends into current portfolio holdings that have suffered significant declines and offer value.

4. Check brokerage account balances to verify that dividends have been received on their payable date. Use the dividend income to pay off any expensive credit card debt.

5. Save between $500 and $1,000 worth of dividends before reinvesting the money and placing orders to buy stocks. For smaller amounts, trading commissions would significantly reduce your investment principal and potential returns.

Tax Implications

1. Review your 1099-DIV form at tax season. The 1099-DIV summarizes your dividend payment over the prior year. The 1099-DIV form groups these payments into ordinary and qualified dividends. Reinvested dividends follow the same tax protocol as all dividend income.

2. Familiarize yourself with the characteristics of qualified and ordinary dividends. As of 2010, qualified dividends are taxed at maximum 15 percent rates, while ordinary dividends may be taxed at 35 percent. For qualified dividends, you must own underlying shares for at least 61 days out of the 120-day holding period surrounding their ex-dividend date.

3. Complete Internal Revenue Service form 1040 to file your personal income taxes. You will enter your ordinary and qualified dividends on the 1040 and on Schedule B. The 1040 instructions booklet includes a Qualified Dividends and Capital Gains Tax worksheet to help you calculate the total tax bill.

Tips & Warnings

• Larger corporations offer dividend reinvestment plans (DRIPs) that can be customized to take automatic monthly withdrawals from your bank account to buy shares. On the payable date, the DRIP administrator automatically reinvests the dividends towards buying more shares of stock in the company. DRIPs are direct investments, which bypass brokerage commissions.

• Retirement plans, such as IRAs, offer tax-deferred growth for reinvested dividend income. Retirement plan balances, however, cannot be withdrawn before age 59 1/2 without severe tax penalties.

References

• Investopedia: Dividend Reinvestment Plan
• IRS: Dividends
• IRS: Retirement Plans FAQs regarding IRAs

Resources

• Investopedia: Why Dividends Matter
• Investopedia: Qualified Dividend