Dividend Reinvestment Plan vs Bonus Share Plan

So, if I'm still 20 years away from accessing my SMSF money, and have been offered the opportunity (through my SMSF WHF LIC holding) both the DRP and the BSP, what are people's thoughts?

I'd love to know what others have done, and why.

 

There were comments in the other threads that DRP are a tax nightmare, if you were to sell. @Terry_w might have further comments here?

 

No I can't comment. You need specific financial advice on this.

 

Whats the difference...DRP or taking the Div's as cash and then buying more shares via DCA (other than brokerage costs)

In my SMSF some I have as a DRP, they just chug along throwing off additional shares over the years, others I take as cash and then when I purchase again I use those funds plus new funds, its all about compounding

 

Tax nightmare I don't know, you just end up with a whole bunch of different cost bases for each parcel that was DRPed.
If you do your own tax returns you might find value in simplifying this by getting the cash and then lumping it together in bigger chunks. But that is a bit of a different strategy though, as you will be buying less regularly. If you were to get the cash and buy the corresponding value of shares with it, it has the same effect as the DRP.

I personally find value in DRP plans as you quite often get a discount on the value of the shares purchased and more importantly I do not need to decide when to pull the trigger. This is a forced DCA strategy element that I like.

 

And no brokerage

 

With the BSP, the paperwork indicates that "the shareholder will by allotted Shares having an equivalent market value to the amount of the dividend entitlement foregone". It also indicates a possible discount, no brokerage etc, at the time of receipt - so pretty much the same benefits as receiving them through a DRP.

I think that future tax implications are the concern, and while I can contact my accountant, does anyone know of any good, quick (and simplistic) explanations e.g. with worked examples, that may help me understand the possible consequences of picking one option over the other?

 

The main difference is the mechanics of it.

Drp is essentially receiving the money from the dividends and the franking credits and buying more shares with it. This creates a tax complexity as you get the income tax from the div & franking credits to calculate, plus a new time stamp for purchasing for cgt purposes.

Bsp is additional shares, sometimes instead of a dividend or sometimes just because the company feels like it. There's no dividend invome bit for tax purposes. Check with your tax advisor on CGT treatment if there's any plan to sell in the future.

 

I thought I read across the threads that holding money back will allow you to buy in dips rather than $ cost averaging which automatically purchases across a range of prices

Tax nightmare only when you sold I thought. I didn't think it affected yearly returns.

 

The thing to keep in mind about things such as DRP is that your money that would otherwise be paid as a dividend will automatically be spent on additional shares at the current price. That price might not necessarily be a bargain price. So you'd need to weigh up whether you prefer to control when you buy.

 

Well, not more a nightmare than if you were to buy the same value of shares with the dividend you received. A DRP is just like buying more shares and each time you buy you have a different cost base. So your only alternative to avoid this "nightmare" is to buy less often and in bigger chunks, which you can do if you take the dividend as cash instead of reinvesting it.

@KayTea With bonus share plans, you forfeit the franking credit - something important to keep in mind. Also the BSP impacts (reduces) your cost base for all your shares, see ato page here: Bonus shares

 

It's not an issue if you never sell


If i'm not mistaken, with the BSP you're receiving the equivalent of a FULL grossed dividend payment without paying tax on this because its not considered 'income', and then purchasing shares from this $ amount.

With DRP, you're receiving a gross dividend, paying income tax (company pays franked amount + you pay any additional amount above 30%) and then purchasing shares with the 'net' dividend.

So in a nutshell, technically you're receiving more shares with a BSP compared to a DRP because you're avoiding income tax and reinvesting the saved $ amount, however the problem arises when you want to sell and the capital gain implications.

Could someone confirm if this is correct? If this is the case, in my scenario (accumulation phase with no intention to ever sell) it makes sense to do a BSP until i want to retire on the dividends.

 

That's true, @JacM, but how do we ever really know when shares are at a bargain price? Often, it's not until they start going back up again.

Using DRP just becomes a way of implementing DCA, and I'd have to hope that, with a number of different share parcels paying dividends throughout the year, surely some would be reinvested at a bargain, and probably some at a premium.

I suppose I could just take the payments as 'cash' and then hold out, to reinvest, when I think they look like a good deal (but my crystal ball is broken, so I'm not sure I trust my judgement).

 

Well, as stated above you forfeit the franking credit with the BSP so it really is only worth it if you are on the highest tax bracket.

 

The WHF BSP and AFIC DSSP are VERY different from a DSP.

There are pros and cons to participating in a DRP as discussed above, but as long as you are disciplined with your investing (eg re-invest dividends rather than spend) and have a reasonable sum to invest then it will make little difference either way.

The BSP/DSSP on the other hand has potential for major downside and less potential for upside. My spreadsheet modelling shows more investors will loose money by participating in the BSP/DSSP. Key points to be aware of about the BSP/DSSP:
- NO franking credits (either as credits or as grossed up dividend)
- Cost base of original and bonus shares are adjusted (eg if you had 100 shares purchased at $10 and received 2 bonus shares the cost base of the now 102 shares would be (100*$10)/(100+2) = $9.80
-NO LIC Capital Gain

As Ouga says, the main people who may benefit from the BSP/DSSP are those on the HIGHEST tax rate who anticipate being on a lower tax rate when they sell the shares (eg children or temporary high income earners / those approaching retirement). Even then, it may not be wise depending on the relative yields and capital gains and how long you plan to hold the shares for.

Participating in the BSP/DSSP CAN COST YOU MONEY. I'm just a regular investor so don't take my word for it, but my modelling tells me that no one should participate in the BSP/DSSP unless they have sought competent advice or are very confident of their own analysis and calculations. I only see downside if the shares are held in a super fund. For everyone, if in doubt then better not to participate.

Even if you plan to never sell, the BSP/DSSP can leave you with less money invested in the long run which leads to lower income stream when you eventually turn the BSP/DSSP off.

 

Thank you so much for this @mimosa - your clarity of expression and detailed reasoning have really helped.

 

It would cost you to use BSP/DSSP in super, you are foregoing the franking credits AND increasing value without altering the cost base. Its a double whammy of bad.

So if DRP or BSP are your options it is a no brainer.

 

In a SMSF, with a buy and never sell strategy, why is this the case ?

During accumulation, the BSP allows you to accumulate shares without tax. Then during pension phase, you can stop the BSP and start receiving dividends tax free ?

 

Yes, but you will accumulate fewer shares via the BSP due to the low tax environment of Super and forgoing franking credits. Assuming fully franked, if the LIC pays a 70c dividend this is $1 grossed up. By taking the BSP you have 70c to purchase more shares but by taking the dividend you have $1 less 15% tax = 85c to purchase new shares. I know which I would prefer

 

Exactly what @mimosa said.

Still, even without the franking credits DRP would be favourable over BSP for the flexibility. You may not plan to even sell, but with no downside you are in a better position if you have to sell.

When you get additional shares with DRP the cost base increases by the price you pay, with BSP is does not, hence capital gains will be less.

As mentioned earlier BSP/DSSP only makes sense to those at high tax rates and even then there are considerations which might make them unattractive.