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Bond interest is fully taxable, while the fixed dividends from Canadian preferred shares are taxed at a much lower rate.
I’m frustrated with the returns from my cash investments and looking for an alternative without raising my risk. Preferred shares seem like a good option, but my adviser says they don’t belong in my RRSP because I’ll lose the dividend tax credit. Am I correct or is my adviser?
—Barry Walsh, Toronto
“There’s no harm in having preferred shares in an RRSP,” says TriDelta’s Ted Rechtshaffen. The tax credit shouldn’t be driving your investment decisions. If you’re considering a preferred share yielding 5% versus a bond that pays 4% with the same level of risk, then you should go with the preferred share, he says. But if you hold bonds in a non-registered account and preferreds in your RRSP “that’s just dumb,” he quips, because bond interest is fully taxable, while the fixed dividends from Canadian preferred shares are taxed at a much lower rate.
But Kerr Financial’s Ted Karon wonders whether preferred shares belong in your long-term portfolio at all. If rates go up perpetual preferreds—which act like long-term bonds and make up most of the preferred share market—will lose value. “Why buy a preferred instead of the common stock if you can get the same yield?” With common shares you can also benefit from price appreciation, he says, whereas preferreds rise in value only if interest rates decline. If you really want to buy preferred shares, Karon recommends variable or “step-up” preferreds, since the yields on these investments will fluctuate with interest rates.
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