WealthPreferred Shares in Canada: Between Bonds and Common Stock
What Are Preferred Shares?
A preferred share is a hybrid security that combines features of bonds (fixed, predictable payments) and stocks (equity ownership in a company). According to GetSmarterAboutMoney.ca, preferred shareholders receive dividends before common shareholders, and in the event of liquidation, they rank ahead of common shareholders in recovering capital.
The trade-off: preferred shares typically carry no voting rights, and their price rarely surges along with company profits. If the business doubles its earnings, common shareholders capture most of that upside — preferred shareholders continue receiving their fixed dividend.
The Three Main Types in Canada
Rate-Reset Preferred Shares
This is the dominant type on the Toronto Stock Exchange (TSX). The dividend is fixed for five years, then reset based on the Government of Canada 5-year bond yield plus a predetermined spread. For example: GoC 5-year yield (3.5%) + spread (2%) = 5.5% dividend for the next five-year period.
This mechanism is important to understand: if rates rise significantly, a reset can be favourable; if rates fall, the new dividend will be lower. This makes rate-resets particularly sensitive to interest rate expectations, especially in the weeks leading up to their reset date.
Perpetual Preferred Shares
These pay a fixed dividend indefinitely, with no reset date. They behave more like very long-term bonds: highly sensitive to interest rate changes, their price falls when rates rise and rises when rates fall.
Floating-Rate Preferred Shares
The dividend fluctuates with a short-term reference rate, often Treasury bill rates. They offer some protection against rising short-term rates but less income predictability than rate-resets or perpetuals.
Comparison: Bonds vs. Preferred Shares vs. Common Shares
| Feature | Bond | Preferred Share | Common Share |
|---|---|---|---|
| Income | Fixed interest | Fixed/variable dividend | Discretionary dividend |
| Priority in liquidation | 1st (creditor) | 2nd (before common) | Last |
| Voting rights | None | Generally none | Yes |
| Upside potential | Limited | Limited | Unlimited |
| Interest rate sensitivity | High | Moderate to high | Indirect |
| Tax treatment (non-reg.) | Interest — 100% taxable | Eligible dividend (tax credit) | Eligible dividend (tax credit) |
| Income type | Stated rate | Tax treatment (non-registered) |
|---|---|---|
| Preferred share dividend | 5% | Eligible dividend — dividend tax credit applies |
| Bond coupon | 4% | Interest — 100% taxable, no credit |
A 5% preferred dividend can cost less in tax than a 4% bond coupon, because dividends qualify for the dividend tax credit while interest is fully taxable.
The Tax Advantage: The Canadian Dividend Tax Credit
This is arguably the biggest draw of Canadian preferred shares in a taxable account. Dividends paid by Canadian corporations are typically classified as eligible dividends, qualifying for the Canadian dividend tax credit at both the federal and provincial level.
In practice, a 5% preferred share dividend may cost you less in tax than a 4% bond coupon, depending on your marginal tax rate. For many Canadian investors in middle-to-upper income brackets, the after-tax difference is meaningful. This is why income-focused investors often hold preferred shares in non-registered accounts and keep their bonds inside RRSPs or TFSAs.
For more on asset location strategy, see our articles on the role of bonds in your portfolio and dividend vs. growth investing in Canada.
Lean perpetual preferreds
- You accept high, ongoing sensitivity to interest rate changes with no reset date
- Price falls when rates rise and rises when rates fall, like a very long-term bond
Lean rate-reset preferreds
- You accept less long-run rate exposure, but high sensitivity right around the reset date
- You also take on call risk: issuers can redeem at a fixed date and price (often $25.00), forcing reinvestment if rates have fallen
Both types carry interest rate risk, but it plays out differently — and rate-resets add a distinct call risk at their fixed redemption date.
Key Risks to Understand
- Interest rate risk: Like bonds, perpetual preferreds lose value when rates rise. Rate-resets are less exposed over the long run, but very sensitive near their reset date as the market prices in the expected new dividend.
- Call risk: Issuers can typically redeem preferred shares at a fixed date and price (often $25.00). If rates have fallen, you may be forced to reinvest at less favourable terms.
- Credit risk: Unlike bond coupons, preferred dividends are not a legal obligation. A company in financial difficulty can suspend dividends without triggering a default. Always check the issuer's credit rating.
- Thinner market: The Canadian preferred share market is smaller and less liquid than the bond or large-cap equity markets. Bid-ask spreads can be wider, particularly for smaller issues.
How to Access Preferred Shares: Direct or via ETFs
You can buy individual preferred shares directly on the TSX, but researching individual issues and managing resets takes time and expertise. Most retail investors access this market through preferred share ETFs, which provide diversified exposure in a single trade and handle the complexity of rate-reset management on your behalf.
To understand how ETFs work in the fixed-income context, see our guide to bond ETFs in Canada.
Preferred shares tend to suit income-focused investors who have already maxed out their RRSP and TFSA, who are in a middle-to-high tax bracket, and who understand that their investment will fluctuate with interest rate movements. They complement a balanced portfolio rather than replace bonds — but in a taxable account, the dividend tax credit makes them worth serious consideration.
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Frequently asked questions
Are preferred shares safer than common shares?
In terms of income priority and liquidation ranking, yes — preferred shareholders are paid before common shareholders. But they are not as secure as bonds, because the issuer has no legal obligation to pay the dividend. Their market price can also fluctuate significantly with interest rates. Think of them as sitting between bonds and common equity on the risk spectrum.
What is a rate-reset preferred share?
A rate-reset preferred share pays a fixed dividend for five years, then the rate is recalculated based on the Government of Canada 5-year bond yield plus a set spread. If rates are higher at the reset date, your new dividend will be higher; if rates have fallen, the reset dividend will be lower. This makes them sensitive to interest rate expectations around their reset dates.
How are preferred share dividends taxed in Canada?
Dividends paid by Canadian corporations are generally classified as eligible dividends and qualify for the federal and provincial dividend tax credit. This makes them more tax-efficient than interest income from bonds in a non-registered account. The exact tax saving depends on your province and marginal rate, but the advantage is real for most middle-to-high income earners.
Why do preferred share prices move when interest rates change?
Because the value of a fixed payment depends on how it compares to what you could earn elsewhere. When interest rates rise, newly issued preferred shares offer better yields, making existing lower-yield issues less attractive — so their price falls to compensate. When rates drop, existing higher-yield issues become more valuable and their price rises.
Can I hold preferred shares inside a TFSA or RRSP?
Yes, preferred shares are eligible holdings in registered accounts. However, the dividend tax credit only applies in non-registered accounts — inside a TFSA or RRSP, income is either tax-free or tax-deferred regardless of type. Many tax advisors suggest holding preferred shares in non-registered accounts to capture the dividend tax credit, and keeping bonds inside registered accounts.
Are there preferred share ETFs in Canada?
Yes, several ETFs listed on the TSX provide diversified exposure to Canadian preferred shares, with most focusing on rate-resets. They simplify management by handling individual security selection and reset tracking, making them a practical choice for most individual investors.
Sources & references
Educational content; verify figures with official sources before acting.