Dividends: should you reinvest or take the cash?

Companies that offer generous dividends can be attractive to investors looking for income.

We look at dividends in more detail, the pros and cons, and whether you should reinvest dividends or cash out.

What is a dividend?

Dividends are payments to shareholders from the profits generated by a company.

They can either be paid as cash or in the form of reinvestment in additional company stock. 

Usually, dividends are paid out per share every quarter, with the amount to be paid determined by the company.

It’s worth looking at the dividend yield of a company, which shows how much it pays out in dividends relative to its share price. 

If, for example, the share price was £10 and the dividend amount was 50p, the dividend yield would be 5%.  

The right yield can draw in investors, but what is seen as a good yield? 

Usually, anything between about 2% and 5%. Below this, the shares won’t be as attractive, and too far above this, it could be riskier. 

How do dividends work?

Dividends are usually paid by companies that generate a profit. Any proposed dividends need to be approved by the board of directors.  

The company will announce any planned dividend payments, including the value per share and the date payment can be expected, alongside other details. 

When dividends are paid out, shareholders can either take the cash or reinvest it to buy more shares in the hopes of better returns.   

Dividends tend to grow in value over time, with many firms increasing the payout each year. This can help lower portfolio risk and volatility.

Companies often use dividends as a way of pulling in funding. 

The advantages and disadvantages of dividends

Dividends have many benefits as they generate passive income and allow shareholders to take advantage of compound interest via reinvestment, as well as offer tax benefits.

However, there are some downsides. It’s worth remembering that dividend income isn’t guaranteed, as it’s tied to the success of a company.

Struggling companies will often cut their dividend for a few years, which could leave you without the income you were expecting.

Unless you hold your dividend-paying shares in an individual savings account (ISA), you’ll pay tax on any dividends paid out that are over the dividend allowance, which is £500 in the 2025/26 tax year.

Should you take cash or reinvest your dividends?

Cashing out your dividends may be worthwhile if you: 

• Want to diversify your portfolio and move into a different area of investment.

• Are close to or at retirement age, and you need the income.

• The company is continually underperforming, and you no longer want to be a shareholder. 

If none of the above apply, you might wonder how to start reinvesting dividends in the company that is paying them out.

You can set up an automatic dividend reinvestment plan (DRIP) with the company or broker, which may incur a fee.  

Once your DRIP is set up, you can reinvest your dividend payouts to buy additional whole or fractional shares.

A fractional share is a part of a whole share, and you can buy these fractions if your dividend payment doesn’t neatly divide into the share price.

Purchases will generally be processed by the start of the next trading day. 

Determining the best dividend-yielding investments

Your broader investment strategy and risk preferences will determine the best dividend-yielding investments for you.  

It’s a good idea to do your research and perhaps contact a financial adviser who can recommend the best investment strategy for your needs and the right investment for you.  

What do I need to pay in tax on dividends?

When you opt to take the cash, you’ll be taxed on your dividends. 

The basic dividend tax rate is 8.75%, the higher rate is 33.75%, and the additional rate is 39.35%. However, this rate is due to increase from April 2026.

Basic rate dividend tax will be 10.75% and the higher rate will be 35.75%. The additional rate remains unchanged.

As previously mentioned, there’s also a tax-free dividend allowance of £500 for the 2025/26 tax year, and this is expected to remain for the 2026/27 tax year.

You’ll only be taxed on dividend income that exceeds your dividend allowance.  

Get expert financial advice

Navigating the world of dividends can be a powerful way to generate income from your investments, offering the choice to either take the profits as cash or reinvest them to benefit from compounding growth.

However, it's essential to understand the associated risks, such as potential dividend cuts, and the complex tax implications, including the annual dividend allowance and varying tax rates for different earners.

Given that the rules and tax rates are subject to change, the decision to invest for dividends, and whether to cash out or reinvest, should align with your personal financial situation and long-term goals.

To ensure you are making the most informed and tax-efficient choices, it is highly recommended that you seek professional financial advice.

An expert can help you build a tailored investment strategy that balances income generation with your overall portfolio objectives.