# Calculating Interest-Rate Equivalents

Trying to figure out the best bet for your money when it comes to investments can get complicated. As you are probably aware, if you receive a dollar of income, the amount of income tax you must pay will depend on that dollar's origin. (Is it from rental properties, interest earned from a bond or GIC, dividends received from a share, capital gains from the sale of an asset, employment income, etc.?) So the different income tax treatment for different types of income makes it difficult for individuals to compare different investment opportunities.

## Apples to apples

It would be easy if we were always comparing apples to apples in the world of investment options. But more often we’re not.

For example, what if you would like to compare an investment in preferred shares with an investment in bonds? Should you invest in a 4.0% preferred share or a 4.25% bond? Which is better? Dividend income is taxed at a much lower rate than interest income. So how do you compare the two types of investments? These are the types of questions that leave a lot of investors scratching their heads.

## Finding the after-tax interest-rate equivalent

One method you can use to answer these questions is to calculate an after-tax, interest-rate equivalent for the preferred share in order to create a level playing field (i.e. you always want to compare apples to apples). This is a simple way to convert the preferred share's dividend yield into an after-tax interest rate so you can compare the after-tax income from the preferred share with that of the bond.

The calculation of the after-tax interest-rate equivalent enables you to convert the dividend yield into an after-tax interest yield. This after-tax interest yield can then be used as a gauge when looking at the interest rate offered by a bond or Guaranteed Investment Certificate (GIC).

Example: Say you're trying to decide whether you should invest the cash balance in your taxable investment account in preferred shares or a bond. Let's say you're looking at a preferred share that pays \$1.00 in dividends per year, per share, for a yield equal to 4.00% and you've found a longer-term corporate bond that pays a 4.25% interest yield. On the surface the bond looks more attractive paying 4.25%. But you also realize that you will pay more income tax on the bond's interest income than you would on the preferred share's dividend income. So how do you compare these two on an after-tax basis? It’s a simple math equation.

Note: You can use the Interest-Rate Equivalent calculator to make quick calculations.

## How to do the math

To compare these two different types of income streams, on an after-tax basis, you will need to calculate an interest-rate equivalent annual return for the preferred share and then compare this number with the bond's annual interest rate:

• Calculate the preferred share's interest-rate equivalent by multiplying the dividend yield by an appropriate multiplier that is generated for taxpayers at the top income tax bracket for each province. (See the table below for a summary of the multipliers.)

Example: Here’s what that mathematical equation would look like: After-Tax Interest-Rate Equivalent = Dividend Yield X Multiplier

If we assume you live in British Columbia and you are paying income tax at the highest marginal income tax bracket, you can use the table below to obtain an appropriate multiplier (where B.C.'s Multiplier = 1.3124). Therefore, in our example of the preferred share with a dividend yield of 4.00%, you can calculate the preferred share's after-tax interest-rate equivalent as the following:

4.00%(dividend yield) X 1.3124(multiplier) = 5.2496%

## Conclusion: compare the results

In the example above we see that for B.C. investors to have the same after-tax income from a bond investment as they would from the 4.00% preferred share, the bond would need to pay a rate of interest equal to 5.25% per year. If the bond investment pays less than 5.25%, then the 4.00% preferred share offers a better after-tax income.

Note: The after-tax, interest-rate equivalent calculation does not include any capital gains or losses that may occur from either a preferred share or bond investment. The calculation simply enables an investor to compare the after-tax annual income streams received.

Additional Note: For a more in-depth discussion on the taxation of dividend income, you can visit MoneySense and read their article titled Delectable dividends.

 Multipliers for highest income tax brackets - 2013 Alberta 1.3231 British Columbia 1.3183 Manitoba 1.2638 New Brunswick 1.3674 Newfoundland 1.3437 Nova Scotia 1.2788 Ontario (\$135,054-\$509,000) 1.3148 Prince Edward Island 1.3547 Quebec 1.2948 Saskatchewan 1.3427 Yukon 1.4595 Source: Scotia Mcleod

 Multipliers for the highest income tax brackets - 2012 Alberta 1.3231 British Columbia 1.3124 Manitoba 1.3410 New Brunswick 1.3674 Newfoundland 1.3437 Nova Scotia 1.2788 Ontario 1.3148 Prince Edward Island 1.3547 Quebec 1.2976 Saskatchewan 1.3427 Yukon 1.4595 Source: Scotia Mcleod

 Multipliers for the highest income tax brackets - 2011 Alberta 1.3489 British Columbia 1.3515 Manitoba 1.3668 New Brunswick 1.3940 Newfoundland 1.3698 Northwest Territories 1.3989 Nova Scotia 1.3101 Nunavut 1.2482 Ontario 1.3400 Prince Edward Island 1.3808 Quebec 1.3161 Saskatchewan 1.3686 Yukon 1.4882 Source: Scotia Mcleod

 Multipliers for the highest income tax brackets - 2010 Alberta 1.3790 British Columbia 1.3952 Manitoba 1.3976 New Brunswick 1.4130 Newfoundland 1.3627 Northwest Territories 1.4081 Nova Scotia 1.3567 Nunavut 1.2835 Ontario 1.3702 Prince Edward Island 1.4068 Quebec 1.3387 Saskatchewan 1.3993 Yukon 1.4097 Source: Scotia Mcleod

A look back at historic multipliers.....

 Multipliers for the highest income tax brackets - 2001 Alberta 1.244 British Columbia 1.247 Manitoba 1.234 New Brunswick 1.286 Newfoundland 1.325 Northwest Territories 1.237 Nova Scotia 1.292 Nunavut N/A Ontario 1.282 Prince Edward Island 1.293 Quebec 1.297 Saskatchewan 1.280 Yukon 1.246 Source: RBC Dominion Securities