Glossary · Dividends
Dividend Reinvestment Plan (DRIP): Automatic Share Buying
A dividend reinvestment plan spends each dividend on more of the same stock, fractions included. The share count compounds, but the tax bill and the record-keeping don't go away.
Definition
Dividend reinvestment plan (DRIP) An arrangement that uses each cash dividend a stock pays to buy more shares of that same stock, often in fractional amounts, without the holder placing an order.
Also called DRIP, Dividend reinvestment program, Automatic dividend reinvestment.
$100 in, 2.5 shares out. That’s one quarter of a DRIP on a small position, and the interesting part is what happens the quarter after, when those 2.5 shares start paying dividends of their own.
The worked example
A hypothetical holding of 200 shares pays $0.50 a share each quarter. The stock trades at $40 on the payment date.
The extra $1.25 is small. It’s also the whole mechanism. Each payment is a little larger than the last because the share count keeps rising, and over many years, if the dividend holds or grows, the reinvested shares can end up producing a meaningful part of the income. The dividend reinvestment calculator runs that forward on your own numbers, with price and dividend growth as inputs.
Two kinds of plan
Broker reinvestment programs are the common one. You switch reinvestment on for a holding, or for the whole account, and on the payment date the broker uses the cash to buy shares, usually including fractions. Many don’t charge. The purchase price is the market price the broker gets that day.
Company-run plans work through the company’s transfer agent. You hold the shares directly with the agent, outside a brokerage account. Some of these plans let you buy extra shares on a schedule, and some offer a small discount on reinvested shares. Terms, fees and enrollment rules are set by each plan. The trade-off is convenience: a company plan holds one stock, so an investor with twenty holdings would have twenty separate plans, twenty sets of statements and twenty transfer agents to deal with when it comes time to sell, which makes a broker program the simpler choice for most portfolios.
Taxes still apply
In a taxable account, reinvested dividends are taxable in the year they’re paid, even though the cash went straight back into the stock and never sat in your account, because the IRS treats the dividend as received and the purchase as something you then chose to do with it. The dividend shows up on your Form 1099-DIV the same as if you’d taken it, and whether it’s taxed at the lower rate depends on the rules for a qualified dividend.
Plan discounts can count as income too. Retirement accounts differ: inside an IRA, none of this is taxed yearly. Situations differ, so check your own case.
Every purchase is a new lot
Each reinvestment is its own tax lot. The 2.5 shares in the example have a cost basis of $100, or $40 a share, and a holding period that starts on the day they were bought.
Years of this means dozens of lots. Brokers track them and report cost basis for most shares bought in the account, but if shares moved between brokers or sat in an older company plan, the history can be incomplete. Keep the plan statements. When you sell, the lots determine your gain, and a lot bought last quarter is a short-term holding even if the original shares are ten years old.
Where you see it
On a brokerage statement, a reinvested dividend usually appears as two lines on the payment date: the dividend credited, then a buy of the same amount labeled reinvestment. The position’s share count shows a fraction. The cash balance doesn’t change.
The dates follow the usual sequence. The purchase happens on or near the payment date, weeks after the record date, as set out in declaration, record and payment dates.
What people get wrong
Thinking reinvested dividends aren’t taxable. They are.
Another is losing track of basis, then overpaying tax on a sale because the reinvested shares were never added to the cost. A third is reinvesting by default into a holding that has grown too large for the portfolio. Reinvestment keeps adding to whatever pays, including the positions you’d rather trim. The case for reinvesting as the default, and the reasons to switch it off, is made in reinvest dividends unless you have a reason.
Readers also ask
Do you pay taxes on reinvested dividends?
Yes, in a taxable account. A reinvested dividend is taxed in the year it's paid, the same as one taken in cash, and it is reported on Form 1099-DIV. Inside an IRA or similar retirement account there's no yearly tax on it. Situations differ, so check your own case.
Should I turn on dividend reinvestment?
Reinvesting suits a long-term holding you'd buy more of anyway, since it keeps the money working without placing orders. It suits a position that has already grown too large far less well, or an account you draw income from. Many brokers let you choose holding by holding.
Can a DRIP buy fractional shares?
Usually. Broker reinvestment programs and company plans typically invest the whole dividend, so a hypothetical $100 payment on a $40 stock buys 2.5 shares. Each purchase then becomes a separate tax lot with its own cost basis and date.