If you are a shareholder of a company, you may receive payments known as dividends.
Dividend payments represent your share of the company's profits and are your reward for investing. Dividends may be a great way to boost your income and are often considered tax effective. Find out exactly how they work and how often you'll get paid.
Why and when companies pay dividends
When a publicly listed company makes a profit, its board of directors decides whether to:
- pay out the profit to shareholders in the form of dividends
- retain the profit to invest in the company's growth, or
- a mixture of both.
Australian companies tend to pay out a high proportion of earnings as dividends compared to companies listed in other countries. This currently sits around 65% compared to around 45% for global sharesi, which could make Australian shares popular with income-seeking investors.
Some Australian listed companies choose to pay dividends twice a year, known as the interim and final dividends. However, dividends are not guaranteed, and some companies don't pay any dividends at all. In fact, a company that has previously paid dividends may decide not to, and vice versa. The size of the dividend can also vary, and often depends on how the company has performed.
Dr Shane Oliver - Head of Investment Strategy and Economics and Chief Economist, AMP Capital says companies like to manage dividend expectations smoothly.
“They rarely raise the level of dividends if they think it will be unsustainable. Sure, some companies do cut their dividends at times, but the key is to have a well-diversified portfolio of sustainable and decent dividend paying shares.”i
Large, well-established companies with stable earnings and certain industries like banks tend to pay dividends consistently. Other companies, such as those involved in developing new technology or medical research, often choose to reinvest all their earnings for research and development and pay no dividends at all. Investors in these types of companies are typically looking for long-term growth rather than income.
How are dividends paid?
Companies generally pay dividends in cash to the bank account that you nominate or send you a cheque.
In some cases, rather than receive a cash payment, investors may be able to take advantage of a dividend reinvestment plan. This involves the company offering investors the choice to use their dividends to purchase more shares in the company, instead of receiving the cash. Often, the shares are offered at a discount to the current market price.
It's important to consider your particular circumstances and goals before deciding what's right for you. For example, investors who want to increase their income may prefer to receive their dividends as cash payments. However, investors who are more focused on growing their wealth may consider a dividend reinvestment plan to help grow the number of shares they own over time. It's a good idea to seek financial advice to help determine a strategy that suits your needs.
How are dividends taxed?
Dividends are considered income for tax purposes. Just like the income you may earn from other sources, like rent from an investment property or interest from a bank account, dividends will be taxed at your marginal tax rate.
The current income tax rates are published on the Australian Taxation Office website.
It's important to keep records of your dividends so you or your accountant can complete your tax return accurately. You'll receive a statement when dividends are paid. If you take advantage of a dividend reinvestment plan, you still need to include the dividend income in your tax return, even if you didn't actually receive the cash payment.
Details of a company's dividend are also published both on the company's website as well as the Australian Securities Exchange (ASX) website.
What are franked dividends?
Companies are required to pay tax on their profits, which means the money they distribute via dividends has already been taxed. To avoid double taxation of company earnings, (once in the hands of the company, and then again in the hands of the investor) these dividends come with a franking credit, also sometimes referred to as an imputation credit. The franking credit represents the amount of tax that has already been paid either partially or in full.
30% tax has already been paid by the company before the investor receives the dividend.
30% tax has already been paid on part of the dividend only. The exact amount will be specified by the company as a percentage.
No tax has been paid.
When you do your taxes for the year, you will receive a credit for any tax the company has already paid. If your top tax rate is less than the company's tax rate of 30%, you'll receive a refund from the Australian Taxation Office (ATO) for the difference. That's why franked dividends are considered tax effective.
We can help you make the most of dividends and create a strategy to help you reach your goals.
©AMP Life Limited. First published July 2018