A simple question on DRP & Tax

[Lithium]

This will probably be a simple one (excuse my ignorance) but I can't find the answer.

Say I have $10k invested in VAS.

I have elected full participation (DRP) as my reinvestment option.

How does this impact my taxable income annually?


Reason why I ask is I see many long term ETF investment strategies cite a full reinvestment plan until retirement, upon which you can just take the dividends instead as income to live off.

Whilst still using a DRP plan, it should still trigger a CGT event anyway and as such, this is taxable income. Correct?

If that's the case, a lot of these strategies for DRP are fine on a 10k investment (the tax will be manageable alongside regular income).

What the hell do you do when you're getting dividend payouts on a 500k investment that yields (hopefully) 30-50k taxable income though? Are people really copping a 20k+ tax bill every year, paying that out of regular income and not touching their DRP reinvested shares?

That's a lot of tax and if you're electing DRP to not take profits but just more shares, how do you effectively manage the tax bill then without selling shares annually to cover the tax bill, copping the broker fee and buying more shares with what's left?

This is the part of the 'reinvest until retirement' strategy that I'm really confused on atm as I've not seen it explained anywhere clearly.

Any experienced help / feedback / advice is appreciated!

 

[greggles]

This will probably be a simple one (excuse my ignorance) but I can't find the answer.

Say I have $10k invested in VAS.

I have elected full participation (DRP) as my reinvestment option.

How does this impact my taxable income annually?

The ATO seems to be pretty clear about it: https://www.ato.gov.au/General/Capi...ilar-investments/Dividend-reinvestment-plans/

You need to include the dividend on your tax return each year whether you receive it in cash or in shares as part as a DRP.

Reason why I ask is I see many long term ETF investment strategies cite a full reinvestment plan until retirement, upon which you can just take the dividends instead as income to live off.

Whilst still using a DRP plan, it should still trigger a CGT event anyway and as such, this is taxable income. Correct?

As I understand it, yes.

If that's the case, a lot of these strategies for DRP are fine on a 10k investment (the tax will be manageable alongside regular income).

What the hell do you do when you're getting dividend payouts on a 500k investment that yields (hopefully) 30-50k taxable income though? Are people really copping a 20k+ tax bill every year, paying that out of regular income and not touching their DRP reinvested shares?

If it yields 30K-50K annually wouldn't the tax bill be between $2,242 and $7,797 each year before any deductions? These figured are based on current tax rates.

 

[Lithium]

If it yields 30K-50K annually wouldn't the tax bill be between $2,242 and $7,797 each year before any deductions? These figured are based on current tax rates.

Even still.. ouch!

I have no doubt there are people with very large (million +) ETF holdings, how the hell are they managing those tax bills before they just retire on the dividend income?

I need to work out some tax reduction strategies I think...

 

[greggles]

I need to work out some tax reduction strategies I think...

Sounds like a good idea. You know what they say about death and taxes. The ATO will always get their cut and it's always prudent to seek advice and figure out how to minimise that amount.

 

[pixel]

consider stocks that pay fully franked dividends. That way you get at least the imputation credits to come off your annual tax bill.
On the issue of DRPs, I believe they're overrated. Possibly okay if you don't have the time or skill to decide on a price point where to add to a holding; but more often than not, the few pips offered as a discount in a DRP are a pittance compared to where the share price will drift down to in the normal course of a year's trading. Buying low is overall more rewarding than buying around dividend time.
If you hold till retirement and then opt out of DRP, the dividend income will continue to be taxed, but the tax-free thresholds for pensioners are such that $50K per annum shouldn't worry you. Neither should the CGT - it'll be half the going rate anyway if you sell some of the long-held shares. By that time, your portfolio will also have a wide mix of positions, some even in a loss situation, that you can manage the total tax burden by judiciously selling selected positions, including some tax-loss sales.

On another, slightly pedantic note: CGT doesn't apply to dividends, regardless whether you participate in any DRP or not. Dividends are income and taxed as such.

 

[Lithium]

CGT doesn't apply to dividends, regardless whether you participate in any DRP or not. Dividends are income and taxed as such.

Thanks for the clarification.

I'd be interested to know what people do then in this situation.

If you're purely DRP until you're grey, that extra 'income' gets lugged onto your normal working income which over time just makes it a big tax bill every year.

I'd be curious as to how people can stay in an ETF for the long term with a full reinvestment plan and still manage the big tax bills down the path.

The only thing that made sense to me was taking the dividend payout instead, putting aside the tax payable from it in the investment account and then using the rest to buy more shares (swallowing the broker fee each time you do it).

Else you're just going to end up with a bigger and bigger tax bill every year until it's impossible to pay reasonably with your normal taxable income wages...

I really feel I'm missing something there as many of the discussions I've read (especially for those seeking to hold until retirement) is how the hell do you reinvest those dividends back into the stock without getting crushed every tax time with a whopping bill?

What happens if you're in like 30 years, have a couple million invested and get back like 200k or something in dividends annually?

I guess at that point you pretty much have to quit work and just take the dividends at that point, the tax bill on that sort of income wouldn't even be feasible to manage on a normal wage without a LOT of tax reduction options if you wanted to just reinvest the dividends.

I'd be interested to see (on average) at what point people think it's not worth working anymore and just switch from DRP over to just getting paid dividends instead due to the tax burden?

 

[pixel]

I reckon you're too optimistic about the rate at which your starting capital increases with dividends alone. Let's take an average of 5% per annum, reinvested into more shares.
$100K starting capital will become -
$162,889.50 after 10 years,
$265,329,80 after 20 years,
$432,194.20 after 30 years, and
$703,998.90 after 40 years.

And if you think 5% is too conservative, be mindful of inflation. If you were collecting postage stamps, for example, you'd be able to compare postage rates 30-40 years ago to today's $1 or $1.50.
Likewise, tax brackets have moved up over time. Do some research on income tax 40 years ago or 20 years ago and compare those rates and sums to today's. You will find the increases far less than your astronomical assumptions. You still pay tax only on the (assumed) 5% of your capital that comes your way as dividends, and if you apply franking credits, you only pay the difference between Company and Personal tax rates; in many cases that will probably be a negative (Credit) amount.

In answer to your last question: Tax-wise, there is no difference between using DRP and having the dividends paid out in cash to you. You pay tax on the dividend amount. It doesn't matter how you spend the money. DRP simply means you spend the money to buy more shares in the issuing company.

 

[Lithium]

Okay thanks for that info!

 

[Sharkman]

I really feel I'm missing something there as many of the discussions I've read (especially for those seeking to hold until retirement) is how the hell do you reinvest those dividends back into the stock without getting crushed every tax time with a whopping bill?

What happens if you're in like 30 years, have a couple million invested and get back like 200k or something in dividends annually?

i don't know of anybody with a portfolio that big who is paying "full fare", as it were, in taxes. they are all using discretionary trusts, SMSFs, negative gearing etc. to reduce their taxes to a more palatable level.

when you reach the stage where you have a portfolio of that size, paying a few grand to a qualified accountant for their services to structure your assets in such a way as to legally minimise your tax shouldn't really be an issue. after everything's all set up the ongoing/yearly accountancy fees should be smaller than the initial fee, and you should wind up saving way more in tax than what you pay in fees.

in fact it's probably better to do it before you get to that point, if you wait until you grow big before you do it, by that point it'll be quite likely that a large proportion of your assets will already be locked up in tax inefficient forms (such as holding them in the individual name of the main breadwinner) that could be costly to release (eg. having to realise cap gains) to get them into more tax efficient structures. though it can be very daunting to drop that amount on accountancy fees when your portfolio is still relatively small, the earlier you do it the more benefits you'll realise once you do grow big.