How do I best optimize my Dividend Reinvestment Account?
by Steve Gail
Now that you have a relatively good idea as to what a Dividend Reinvestment Plan is and how it works, an understanding as to where the best place to utilize it should be briefly discussed. First of all, in the total scheme of your investments let's examine the priority your Dividend Investment Plan should be placed. In terms of your overall investment philosophy, I believe in no uncertain terms that your initial concern for investments should be toward your 401(k) or 403(b)
plan. Any monies that you have should be placed in your current employer plan, especially if your employer matches any portion of your contribution. The rational is simple, your investments in your 401(k) are invested with pre-tax dollars, and in addition; depending on your plan's matching provisions your employer might match any of your contributions up to a specified percentage (usually somewhere between 3-5% or more varying by company.). So your number one investment should be to fully fund your 401(k). In other words, you should make the maximum contribution to your plan that is at all possible during any given year. It is at that time, and only at that time, should one consider any alternative investments. The next best investment consideration should be a ROTH investment.
Why a ROTH Investment? (Individual Retirement Account)
The reason for a ROTH retirement plan at this time is logical.
Now that you have fully funded your 401(k) plan for the year, you need to be able to use the next most tax-advantaged vehicle that can be utilized. The ROTH IRA has many unique advantages and if we tie them together with a Dividend Reinvestment Program we have the best place to actually maximize our DRIP plan.
Why a DRIP (Dividend Reinvestment Plan) inside of a ROTH IRA?
There are several reasons that a DRIP is best suited for a ROTH IRA.
They are as follows:
1. All Dividends, regards of current of pending tax taxes,
can be reinvested tax-free. The reason, in a ROTH IRA, all money invested is invested on an after tax bases, hence when the money is withdrawn no taxes are paid on those withdrawal. So, all of your dividends that were reinvested, will now be tax-free distributions at retirement or after age 59 1/2.
2. Since you may contribute up to $3,000 a year in your ROTH IRA, all of your automatic cash option purchases made in your DRIP account that are eventually sold are also treated tax-free when distributed.
Since, there are no taxable consequences on any of your distributions; this leads me to the next advantage with your DRIP plan being in a ROTH IRA. The need to establish cost basis by constantly keeping records as to purchase dates becomes a moot point, since all the distributions are tax-free, holding periods become inconsequential.
Now, I don't want anyone to leave with the idea that the only way to utilize a DRIP plan is inside of a ROTH IRA, but to optimize the Dividend Reinvestment Plan one will find the use of the ROTH probably offers the best vehicle from within to use in conjunction with your DRIP.
Next week we will examine the attractiveness of high yielding Utility companies that currently offer Dividend Reinvestment Programs (DRIP).
Until next time,