In the world of equity securities, dividends are payments made by corporations to shareholders as a means of distributing business profits. In most cases involving publicly traded companies, most of the dividends are reinvested and a fraction thereof is paid to shareholders; on Wall Street, this tends to happen on a quarterly basis for so-called “blue chip” stocks.
Dividend payments are a matter of public record, and they are usually paid into a brokerage account and are treated as taxable income in the United States. When it comes to 401(k) retirement plans, however, dividends are often handled differently. Depending on the management style of the 401(k) plan and the investments held, some participants may not get to see dividends in their financial statements, even if they see news reports about dividends on publications such as the Wall Street Journal.
When 401(k) plans are presented to American workers, they get to choose from a number of investment options. To this effect, stock funds happen to be among the most popular options, and they often include stock from the company that the employee works for. In this case, employees get to decide how stock dividends paid by their employers should be distributed.
Should a 401(k) participant choose mutual funds from a reputable management firm such as Vanguard, they will not have a choice as to what happens to the dividends earned by the shares held in the fund; in this case, the dividends are reinvested. It is important to note that this reinvestment creates an advantage in terms of taxation; when a participant chooses to make an early withdrawal from the 401(k) account, reinvested dividends are taxed as ordinary income instead of capital gains.
For companies considered to be market leaders or Wall Street giants, 401(k) plans present an opportunity to conduct a bit of financial advertising. A company such as Microsoft, for example, stands to gain a valuable shareholder each time an employee signs up for one of their 401(k) plans and elects to invest part of his or her salary into shares of the company. Under qualified employee stock ownership plan (ESOP) rules, 401(k) participants must be given the option of reinvesting or paying out dividends from company stock.