The Pros And Cons Of DRIP IRAs -- 10/1/2004

DRIPs represent an excellent vehicle for long-term investing. However, incorporating DRIPs into a long-term investment vehicle, such as an Individual Retirement Account, is difficult. The problem with holding company-sponsored DRIPs in a traditional or Roth IRA is finding a custodian for the account. Traditional custodians for IRAs are brokerage firms and mutual funds. As you know, in order to enroll in company-sponsored DRIPs, stock must be registered in the investor’s name, not the brokerage name. However, once stock is registered in your name, the broker is removed from the process. Since brokers have no place in traditional company-sponsored DRIP programs, you cannot expect brokerage firms to administer an IRA that includes company-sponsored DRIPs. And don’t expect a mutual fund to hold DRIPs either.

 

Because of the difficulty of including company-sponsored DRIPs in an IRA, a small number of companies offer an IRA option (including Roth IRAs) in their DRIP plans:

 

Name/Symbol	Min. Initial Investment	Name/Symbol	Min. Initial Investment
Allstate (NYSE: ALL)	$500	Ford Motor (NYSE: F)	$1,000
Altria (NYSE: MO)	$500	McDonald’s (NYSE: MCD)	$500
AEP (NYSE: AEP)	$250	ProLogis (NYSE: PLD)	$200
Aqua America (NYSE: WTR)	$500	SBC Comm. (NYSE: SBC)	$500
Campbell Soup (NYSE: CPB)	$500	Sears (NYSE: S)	$500
ExxonMobil (NYSE: XOM)	$250	Verizon (NYSE: VZ)	$500
Fannie Mae (NYSE: FNM)	$250	Wal-Mart (NYSE: WMT)	$250

 

As you can see, there are a number of popular, blue-chip names on this list. But just because a company offers a DRIP IRA does not necessarily make it a good option for all DRIP investors. Here are some pros and cons when it comes to DRIP IRAs.

Pros:

• The first pro is the fact that DRIP IRAs offer an easy way to actually DRIP invest within an IRA. Given how difficult it is to hold company-sponsored DRIPs in broker-administered IRAs, this is a huge plus.
  
  
• DRIP IRAs eliminate any tax hassles that may arise when trying to determine your cost basis in a DRIP plan. Many investors are turned off by DRIPs as a result of a perceived hassle in determining the cost basis. The cost basis is basically what you paid to purchase an investment. When you sell an investment, Uncle Sam wants to know whether you have a gain or loss on your investment. If you have a gain, you’ll have to pay taxes on the gain. If you are in a DRIP plan for many years and do frequent optional cash investments as well as regular dividend reinvestments, it may be a chore to compute your cost basis when it comes time to sell part or all of your DRIP holdings. Investing in a DRIP IRA, however, eliminates the tax hassle of keeping track of your cost basis. Indeed, no taxes are paid on IRA investments. And when IRAs are liquidated, taxes are paid at ordinary rates. Thus, investors who own DRIPs in an IRA never have to worry about computing a cost basis for tax purposes. Also, you don’t have to worry about computing taxes each year on dividends that are reinvested in the DRIP IRA.

Cons:

• The biggest downside of DRIP IRAs are the fees. In most DRIP IRAs, there is an annual administrative fee, usually $45. That may not sound like much. But that $45 fee will take a big bite out of your IRA investments if you are investing relatively small amounts of money. And the annual administrative fee doesn’t take into account other fees, such as regular purchase fees of $5 or more that you may incur when investing in some DRIP plans. Also be aware that DRIP IRAs charge a termination fee of $75. Because of the heavy burden of fees on small investments, investors who plan to invest only relatively small amounts of money in an IRA are probably better off looking at a low-cost, no-load mutual fund as an IRA vehicle.
  
  
• Another problem with DRIP IRAs is that you can invest in only one company per IRA. You cannot hold multiple DRIPs in a single DRIP IRA. Therefore, if you want to diversify your retirement investment across a series of DRIP IRAs, you’ll have to open up multiple DRIP IRAs and incur multiple fees.

Bottom line: DRIP IRAs may have their place in a portfolio. But investors should consider carefully how they plan to invest in the plans and whether the fees and lack of diversification should cause them to consider other IRA vehicles, such as no-load mutual funds.

 

Which DRIP IRAs do I prefer? ExxonMobil (NYSE: XOM) represents a quality long-term investment perfect for an IRA. You will not pay any fees to purchase stock in the ExxonMobil DRIP IRA. However, ExxonMobil charges an annual fee of $45 to administer the IRA. In fact, the only DRIP IRA on the list on page 1 that does not charge an annual fee of $45 is Aqua America (NYSE: WTR). This water utility has a stellar track record of growth. Aqua America’s DRIP also has no purchase fees.

 

All of the DRIP IRAs listed here permit investors to buy their first share and every share of stock directly from the company. Please note that all of these DRIP IRAs are administered by EquiServe. For further information about the DRIP IRAs, contact EquiServe at (800) 472-7428 or visit EquiServe online at www.equiserve.com.

Back to Top