DRIP Warning

By | 06/28/2011

The dividend reinvestment plan (drip) offered at most brokers is a tool for investors, it takes company dividends paid to shareholders and automatically buys more shares for them. For example if today you bought 100 shares of Bank of America for $10 per share, you would have 100 x $10 = $1000 worth of stocks in BoA. This means your ACB is $1000. Then let’s say they offered a special dividend of 10 cents per share to shareholders. Since you own 100 shares, you would get $10. This money would then buy you exactly 1 more share of the company, assuming it’s share price is still $10. Congrats, now you have 101 shares at $10 each, so your portfolio is now worth 101 x $10 = $1010.

But wait, if these stocks are held in a non-registered account please don’t forget to adjust your ACB. You should recalculate your ACB as if the share(s) bought with the DRIP was using your own money. In this example, think of it like you bought 1 more share using $10 from your pocket on the same day you received the dividend. So your ACB is now $1010.

Which means if you sold all our holdings, 101 shares. You don’t have to pay any taxes at all, even though it appears like you made $10 in profit, or a 1% return. You already paid taxes on the $10 dividend, don’t make the mistake of paying another tax on a $10 capital gain. Some investors overlook this small detail and pay double tax; once when they receive the dividend, and once more when they sell the equity. Luckily most discount brokerages will do the math for you and adjust your ACB so you don’t have to. If this sounds like too much information then consider only DRIP your RRSP and TFSA accounts, or other tax deferred vehicles like the 401K in the US.

For simplicity’s sake I’ve left out commission fees and any tax liabilities in the above example.

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