How Do I Choose the Best Reinvestment Plan?

Malcolm Tatum

A reinvestment plan is a type of financial tool that makes it possible to transfer or reinvest assets from an existing account to a new one that is capable of allowing that investment to continue growing. There are plans of this type that are designed to allow employees to roll over the balances of employee sponsored retirement plans into other savings plans, as well as stock reinvestment plans that allow investors to take dividends earned on currently held investments and use those proceeds to buy additional shares of stock. Choosing the right reinvestment plan requires carefully evaluating the potential of each possible strategy, assessing the degree of risk involved, and also considering what type of tax benefits or liabilities may occur as the result of the move.

A dividend reinvestment plan should focus on the opportunity to buy more stocks.
A dividend reinvestment plan should focus on the opportunity to buy more stocks.

One of the first points to consider with any reinvestment plan is what type of returns can reasonably be expected from the move. The idea is to make sure that the reinvested assets have the chance to aid the investor in moving closer to his or goals. This requires looking closely at the type of returns that are likely to be realized over time. For example, if an investor leaves an employer and must roll the balance of a retirement plan into a new account, the goal will be to choose a reinvestment account that is likely to produce at least the same type of growth as the old plan. In like manner, a dividend reinvestment plan should focus on the opportunity to buy more stocks with those dividends that are capable or producing similar returns as the stocks already held in the portfolio.

Along with gauging the potential of the reinvestment plan, it is also important to identify the degree of risk associated with the new plan in comparison to other options. The goal is to make sure the risk level is in line with the potential rewards, and ideally involves the same or even less risk that the original investment strategy. Paying close attention to this aspect of the reinvestment plan is particularly important when moving investments to a new type of plan that is very different from the originating one.

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In addition to assessing growth potential and the related risk, it is also important to consider the tax ramifications of the reinvestment plan under consideration. Depending on tax laws relevant to the investor, some methods may create a tax burden that must be honored. When and as possible, the goal is to identify a reinvestment plan that allows the transfer to take place without calling for any taxes to be paid at that time. Plans with some sort of tax deferred arrangement mean that the investor does not owe taxes until withdrawals are made from the plan and used as a source of income. Doing so means more money goes into the plan, dividends and interest can accrue on that balance, and ultimately the plan is positioned to generate additional returns for the investor.

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