Preferred Shares Offer Higher Yields—and Lower Tax Rates

With bond yields having surged in the past month, one of the more appealing areas now is the preferred stock market, where yields top 7%.

Preferred dividends generally are taxed favorably, like those on common stock, at a maximum federal rate of 23.8% , while corporate debt is taxed as ordinary income at a maximum federal rate of 37%. A 7.5% preferred yield is equivalent to more than 9% on a corporate bond. Investors would need to buy junk-grade corporate bonds to get similar after-tax yields on what is mostly an investment-grade preferred market.Investors can buy individual preferreds directly or through funds.

Banks account for about half the market. JPMorgan Chase is the largest issuer. Bank preferreds invariably are tax-advantaged. The country’s largest banks look safe—protected by ample capital and an implied federal backstop. “Credit spreads are wider than average for banks, and the credit story is improving,” says Douglas Baker, head of preferred stock investing at Nuveen. He says steps by regulators to boost bank capital ratios and subject more banks to stress tests make the industry safer.

In the past few months, Wells Fargo, Citigroup, and Goldman have issued $1,000 preferreds with yields of 7.5% to 7.625%. The Wells Fargo and Goldman issues trade around face value, while the Citi issue is down to 96 cents on the dollar, lifting its yield to 8%.

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