\nGICs pay a guaranteed return, expressed as an interest rate paid on the amount invested, which is taxable as interest income in a non- registered account. Since they aren\u2019t tradeable assets, they don\u2019t vary in price. At maturity, the original investment is returned to the investor. Bonds, on the other hand, generally pay a coupon, or annual interest rate (sometimes paid semi-annually), which is taxable as interest income. The coupon rate is expressed as a percentage of the bond\u2019s \u201cface value\u201d \u2014 the amount paid to the bondholder at maturity. Over the life of the bond, a bond\u2019s price can vary as interest rates change.<\/p>\n
If interest rates were to rise, any comparable bonds would now offer a higher coupon amount. As such, the bond that was issued at the lower interest rate, which pays a lower coupon, will need to fall in price so that its coupon and eventual face value paid at maturity will be equivalent to the new bond. When a bond is sold for less than its face value, it is termed a \u201cdiscounted bond.\u201d Conversely, if interest rates fall, the bond\u2019s price will rise. If it is sold for more than its face value, it would be sold at a \u201cpremium\u201d (or above par).<\/p>\n
Discounted Bonds: A Tax Advantage<\/strong> To illustrate the tax efficiency of a discounted bond compared to a GIC, the chart compares a bond offered by a $14 billion Canadian packaged foods company with a yield to maturity of 5.06 percent to a GIC that pays interest at 5.05 percent. Based on a tax rate of 52.54 percent, the after-tax return for the bond is 2.99 percent, whereas the GIC\u2019s return is only 2.40 percent once taxes are considered. In fact, on an initial $1 million investment, the net after-tax income is $5,906 more for the bond than for the GIC.<\/p>\n In some cases, even if a GIC has a higher pre-tax expected return than a discounted bond, the after-tax returns of the discounted bond may be notably higher. In addition to the tax advantage, many quality bonds are more liquid than GICs. As well, in a situation where future interest rates decline, there may be an opportunity for investors to realize gains before the bond reaches maturity. Since many quality bonds currently trade at a discount, investors may be able to find appropriate portfolio additions that meet their risk tolerance, while offering higher after-tax returns than GICs. To learn more, please feel free to call the office.<\/p>\n","protected":false},"excerpt":{"rendered":" Given the rise in interest rates since the start of 2022, there has understandably been greater interest in low-risk, fixed-income investments like Guaranteed Investment Certificates (GICs). While investors can take advantage of rates not seen in decades, it is important to consider the tax implications. When a GIC is held in a non-registered account, any […]<\/p>\n","protected":false},"author":68,"featured_media":1571,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_oasis_is_in_workflow":0,"_oasis_original":0,"_oasis_task_priority":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"footnotes":""},"categories":[24],"tags":[57,63,58,61,64,65,45,49],"class_list":["post-715","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-articles","tag-asset-management","tag-assets","tag-economic-insights","tag-finance","tag-interest-rates","tag-retirement","tag-saving-strategy","tag-wealth-planning"],"yoast_head":"\n
\nWhat makes a discounted bond attractive from a tax perspective? Since the bond was purchased at a discount from its face value, part of the total return from the bond comes from capital gains. The coupon amount would still be taxed as interest income; however, the capital gain would be subject to a lower tax rate. This makes the discounted bond more tax-efficient than a comparable GIC with returns fully taxable as interest income.<\/p>\n![\"\"](\"https:\/\/advisor.wellington-altus.ca\/towerwealthadvisory\/wp-content\/uploads\/sites\/37\/2023\/12\/A-TAX-EFFICIENT-ALTERNATIVE-TO-GICs.jpg\")
\nWhat accounts for such a difference? Since capital gains are treated more favorably, as a result, the blended tax rate is only 41 percent for the bond, compared to 53 percent for the GIC.<\/p>\n