Sometimes people ask, what rate of return can I get? The answer to that question is in part, whether you want your money back? Junk bonds pay higher rates but the name is a hint of a potential outcome.
Assuming you use a normalized benchmark like five or ten year Canada bonds, many Canadians are realizing that current low interest rates offer a negative return, net of inflation and taxes.
So there are two considerations when seeking higher income…
- Alternative sources of income.
- Alternatives to how you are taxed on that income.
Canadian dividends often pay more than interest and are always taxed more favourably.
Let’s use hypothetical financial institution ABC. Let’s assume your top marginal tax rate is 47.7% (BC)
ABC offers a five year GIC at 1.6%. ABC also offers a dividend to its shareholders (owners) at 4%
As a depositor ABC uses deposits to make money.
As an owner, ABC pays a dividend to its shareholders (owners).
This example is reflective of how things often look with financial companies in this low interest rate environment, but the same comparison could easily be made between Government of Canada bonds and the higher paying dividends available via many Canadian corporations.
Interest and Dividends are also taxed differently.
For a top marginal tax rate investor in British Columbia, Interest is taxed at 47.7%. Dividends are taxed at 31.30%
As a depositor at ABC, the 1.6% interest turns into 0.96% after-tax.
As a shareholder of ABC, the 4% dividend turns into 2.75% after-tax.
There is also a way to potentially increase total income beyond that offered by dividends by using a hedging strategy called covered call writing – see Why Us?
Finally, a big difference between investing in deposits or Government bonds is that deposits and government bonds have certain guarantees pertaining to your capital. Owners of shares in a corporation have NO guarantees pertaining to capital. As a result, we seek to build portfolios that reduce that risk by means of diversifying risk among many individual company shares versus few.
*NOTE: Please consult your tax advisor regarding your particular situation. National Bank Financial is not a tax advisor and clients should seek professional advice on tax-related matters. Please note that comments included on this website are not intended to be a definitive analysis of tax law. The comments contained herein are general in nature and professional advice regarding an individual’s particular tax position should be obtained in respect of any person’s specific circumstances.