Dale Jackson

Personal Finance Columnist, Payback Time

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With bond yields in the cellar, dividend stocks are about the only game in town for income-hungry investors. But instead of taking a dividend payout in cash, consider diverting it to a dividend reinvestment plan. DRIPs automatically reinvest dividend payouts in more shares of the original security. They can be used with individual stocks, mutual funds, or exchange-traded funds (ETF).

There are there big advantages to signing up for a DRIP:

1. Dividends are compounded. When a dividend payout is used to purchase more stock, that stock pays dividends, and so on and so forth.

2. Public corporations, mutual funds, and exchange-traded funds offering DRIPs often waive commissions and sometimes provide new shares at a discount.  

3. It’s a good form of dollar-cost averaging. Making purchases of an investment over regular intervals smooths out volatility. If the price of the security falls, you purchase more at a lower cost, bringing your break-even point lower. If the price goes up, that’s great, too.    

Publicly-traded corporations favour DRIPs because they help drive the price of their stock higher and tend to have a stabilizing effect. Mutual funds and ETFs that generate dividends will usually default to a DRIP, but you can elect to get your payout in cash.

There are, however, tax implications with DRIPs. They are still taxed as dividend income. That means they are fully taxed when withdrawn from a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF).

They are also taxed outside of a registered plan, but a dividend tax credit is available for eligible Canadian dividends stocks.

If you want to avoid being taxed on dividends, a tax-free savings account (TFSA) will do the trick.