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The Tax Advantages of Preferreds

January 28, 2021

Preferred stocks may offer potential tax advantages for investors, with high current income both before and after taxes. Preferreds can offer this due to the fact that many of them qualify as being QDI1-eligible. This means that their dividends are taxed at the dividend tax rate, not as ordinary income.

As you can see in the chart above, from a current yield “before tax basis”, preferred stock yields are relatively high in relation to other traditional income producing assets.

When you take the example one step further and look at preferreds from a “taxable equivalent yield basis”, QDI eligible preferred stock yields are even more attractive, with a taxable equivalent yield of 6.44%.

This not only makes preferred stocks an attractive holding in retirement accounts, it also makes preferreds an attractive holding in taxable accounts as well. Especially as a compliment to municipal bonds.

Source: Flaherty Crumrine, Bloomberg, Barclays Live, S&P, FRED

1 Assumes a marginal income tax rate of 37% a 3.8% Medicare surtax on investment income and a QDI rate of 20%.

2 QDI: Qualified Dividend Income tax rules allow certain dividends from US corporations and qualified foreign corporations to be taxed at rates lower than ordinary income tax rates.

Definitions High Yield Bonds ICE BofA ML U S HY Master II Yield Index Baa Bonds QDI Eligible Preferreds Flaherty Crumrine proprietary database Moody’s U S Baa Corporate Bond Index Aaa Bonds Moody’s U S Aaa Corporate Bond Index 30 Year Treasuries 30 Year U S Treasury CM Municipal Bonds Bloomberg Barclays Municipal Bond Index 10 Year US Treasury 10 Year U S Treasury CM S&P 500 Index All information is historical and for illustrative purposes only Past performance does not guarantee future results.

Related Preferred Articles

We all know how annoying telemarketing calls can be and frankly, many of us just don’t like being called. Well, there is an analogy to that in the investing world, with income securities like preferreds, most of which have provisions that allow them to be called after a certain date at the issuers discretion.
The preferred market space is complex and nuanced. No two preferreds are alike. In this video, Eric Chadwick of Flaherty and Crumrine Incorporated breaks down some specific examples.