Beware the tax trap of these tempting preferreds

John Heinzl was kind enough to quote me in his latest piece for the Globe and Mail, Beware the tax trap of these tempting preferreds:

The banks gave themselves the option to redeem the shares on the reset date. With preferred yield spreads having contracted sharply now that the financial system has stabilized, “virtually all of them are going to be called,” says preferred share expert James Hymas, president of Hymas Investment Management. Any high-quality preferred with a spread of at least three percentage points is pretty much a lock for redemption, barring another financial crisis, he says.

“Most investors look only at current yield,” Mr. Hymas says. But the more important number is the “yield-to-call” (similar to the yield-to-maturity of a bond), which also takes into account the expected capital loss or gain. In the case of RY.PR.T, the yield-to-call is about 2.3 per cent.

There are tax implications, too. If you’re investing in a non-registered account and buy a rate-reset preferred with a current yield of 6 per cent, you’ll have to pay tax on the inflated dividend. Even taking into account the dividend tax credit and assuming you can use the capital loss to offset other capital gains, you could end up paying an effective tax rate of more than 30 per cent on the yield-to-call of 2.3 per cent, Mr. Hymas says.

“Before you even think about buying them, you have to do your calculations properly and account for taxes, if any,” Mr. Hymas says.

For more on preferred share yields, plus a link to an online yield calculator, read Mr. Hymas’ article at

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