Dividends explained: types, brokers, & how they are taxed

There are two ways to make money when investing in stocks: capital gains and dividends. Dividends are also a way o generating passive income, as you only need to be a shareholder to receive dividend payments.

In this article, we’ll discuss some of the most common questions related to dividends – such as what they are, when to buy stocks to receive dividend payments, what rights you have as a shareholder, and more.

What are dividends?

A dividend is a portion of a company’s profits that is given to its shareholders as a reward for investing in the company. The amount of profits to be distributed to shareholders and when (the dividend policy) is decided upon by the board of directors.

Essentially, when a company generates profits, the board of directors determines whether to reinvest all profits or distribute a portion (or even all profits) as dividends among the shareholders. These dividends are essentially rewards provided to individuals who hold shares in the company, forming part of the benefits of being a shareholder.

Many well-established companies choose to reinvest a portion of these profits and distribute the remainder to shareholders, either in the form of cash or additional shares.

What rights do shareholders have?

A share represents ownership in a company. Some of the main rights include voting rights at general meetings and entitlement to a share of the company’s profits in the form of dividends.

However, it’s important to note that not all companies distribute dividends. Many high-growth companies, such as technology companies, reinvest all profits and do not pay any dividends.

In this case, the investor’s gains only come as capital appreciation (share price increases).

Who is entitled to receive dividends?

Investors must buy stocks before the ex-dividend date. The ex-date is the day when the stock starts trading without including the next dividend payment.

When the board of directors establishes the dividend amount, the record date is also established. The record date is when a person must be on the record as a shareholder to receive the payment.

Once the record date is set, the ex-date is also set, based on the rules of the stock exchange on which the stock is traded. Usually, the ex-date is one business day before the record date.

Hence, you need to buy the stock before the ex-date to receive the dividend.

Is there a minimum dividend amount?

There is no minimum when it comes to dividends and collection. As long as you are a shareholder, you have the right to collect the dividend.

Types of dividends

A company can distribute the regular dividend (traditional dividend), but sometimes it may decide to distribute a special dividend or an extra dividend. Special dividends are often one-time and linked to a special event, such as a large sale or corporate restructuring.

In addition, the most common types of dividends are cash dividends (paid in cash) and stock dividends (paid in stocks.

DRIP – Dividend Reinvestment Plan

Some companies offer DRIP, which stands for Dividend Reinvestment Plan. It’s a program that provides shareholders with the choice to automatically reinvest their cash dividends back into the company by purchasing additional shares of the company’s stock. This allows shareholders to potentially accumulate more shares over time without having to actively buy them on the open market.

When are dividends distributed?

Each company is free to make its own dividend policy. Some companies distribute dividends annually, others quarterly. You need to check the company’s information to find out exactly when dividends are distributed.

Here are some concepts you should be familiar with:

• Dividend announcement date: The Board of Directors announces the amount of the dividend, the record date, and the payment date.
• Ex-dividend date: As explained, to qualify for the payment, you must be a shareholder before the ex-date.
• Record date: This is the date when the company checks to see who the shareholders are (usually one business day after the ex-date).
• Payment date: The dividends are paid to the shareholders.

Dividend stocks on the London Stock Exchange

Here are the top FTSE dividend-paying stocks:

Best brokers to invest in dividends

Here are some of the best brokers to invest in dividends:

Types of dividend-paying stocks

Here are two key concepts to know if you are new to dividend investing:

Dividend aristocrats

Dividend aristocrats are companies that have demonstrated a long and stable history of increasing dividend payments over time. These companies are usually stable and are considered defensive investments because they can provide a constant source of income for investors through dividend payments.

To qualify as a dividend aristocrat, a company must meet certain requirements, such as having a history of at least 25 years of annual dividend increases and having a specific market capitalisation. These companies also tend to have a stable cash flow and low debt relative to their earnings, such as Air Products & Chemicals or Lindt.

Find out more about dividend aristocrats.

Dividend kings

Dividend kings are a select group of companies characterised by having maintained a stable and increasing dividend history for an even longer period than the dividend aristocrats. That is, these companies have paid dividends and have increased them without interruption for at least 50 consecutive years.

Like the dividend aristocrats, dividend kings are also considered defensive investments, but more robust than the aristocrats.

Learn more about investing in dividend kings.

What is the link between share price and dividends?

Generally, when a company announces higher dividends or consistent dividend payments, it can positively influence investor sentiment and potentially lead to an increase in the company’s stock price. Conversely, reductions or omissions in dividends might lead to decreased investor confidence and a potential decrease in the stock price.

After the company pays out the dividend to shareholders, the stock price typically adjusts downward to reflect the distribution of funds from the company’s coffers to investors. This adjustment is not a loss for shareholders; it’s a natural reflection of the funds leaving the company. This drop in stock price after the dividend payment is known as the “ex-dividend” effect.

The ex-dividend date is the date after which a buyer of the stock is not entitled to receive the recently announced dividend. On the ex-dividend date, the stock price usually drops by approximately the amount of the dividend. This is because investors who purchase the stock on or after the ex-dividend date will not receive the upcoming dividend payment, and the stock price adjusts to reflect this.

How are dividends taxed? Everything you need to know

If the dividend amount falls within your personal allowance, you don’t pay any tax on it. You also have a dividend allowance of £1,000 per year – if your dividend payment is within this limit, it’s not taxed. Also, you don’t pay tax on dividends from shares held in an ISA.

However, if you do qualify to pay tax (i.e., the dividend amount is higher than the specified limits), you will have to pay tax based on your income tax band, starting at a basic rate of 8.75% (but only on what exceeds the limits).

Your income tax band depends on your other sources of income.

Advantages and disadvantages of having dividend stocks in your portfolio

Here are some advantages and disadvantages of owning dividend stocks:

Other dividend investing articles

• Dow Jones stocks with the best dividends
• Best dividend stocks
• Beginner’s guide to dividends
• Best brokers for beginners

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