Dividend reinvestment plans provide attractive benefits
Fund manager criticism that the issuing of new shares via dividend reinvestment plans results in the dilution of investors' equity in their companies is largely misguided. The banks especially will continue to face pressure to maintain or even increase their capital reserves. Unless they can use dividend reinvestment to add to their reserves, they and other companies could be forced to reduce their dividend payouts to preserve capital.
From the shareholder viewpoint, there are substantial tax benefits from high fully franked dividend payouts. The 30 per cent company tax paid on income funding these dividends is credited fully against the recipient's tax liability.
Charities, pension funds and non-taxpaying resident individuals receive a full refund of this company tax via the imputation credit system. Superannuation funds subject to 15 per cent tax receive a tax credit of the remaining 15 per cent of the 30 per cent company tax.
To the extent that companies restrict their dividend payouts from income subject to the full 30 per cent tax, these categories of shareholders lose out by not obtaining a refund of some of the company tax paid by the companies in which they own shares. Many companies have been increasing their fully franked dividends to shareholders because the government may, as proposed in the election campaign, reduce the company tax rate to 27 per cent as part of the paid parental leave plans. If this eventuates, income taxed at 30 per cent in the past would attract imputation credits at only a 27 per cent rate when the lower company tax rate is introduced. This is an incentive for companies to increase their fully franked dividends, as they have been doing.
There are additional benefits from higher dividend payouts as well, particularly from the boost in share prices. While many shareholders forgo the opportunity to reinvest their dividends, those that do still receive the same franking credit benefits as those who opt to accept additional shares rather than cash.
It is difficult, moreover, to argue that the investors taking their dividends as cash lose out from the issue of new shares to those who don't. This is because new shares are issued under reinvestment plans at prices equal to or just below the current market price of the share. This price has been boosted by the demand from income-seeking investors attracted by high dividend payouts.
For investors building capital or in superannuation funds not making payouts to members, dividend reinvestment plans offer an attractive low-cost way to accumulate assets, provided the share price is still attractive. Given there is no compulsion to sign up to reinvest dividends, overall dividend reinvestment plans provide real benefits to self- funded retirees and others seeking high income from their investments, even if they don't sign up themselves.