Low CSB rate makes strong case for inflation indexed bonds|
Jonathan Chevreau • The National Post • October 12, 2001
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If ever there were an argument for inflation bonds, it's the current interest paid by the new series of cashable Canada Savings Bonds: 1.8% -- the lowest rate CSBs have paid in half a century.
Imagine a retiree trying to live on that interest. You'd need $1-million of capital just to generate an $18,000 annual income that would keep your head above the poverty line. After taxes and inflation, you'd be even worse off.
If you're still in your earning years, in the top tax bracket and trying to supplement an RRSP with non-registered savings, Ottawa would be raking off about 0.8% of that paltry 1.8% yield. You'd be left with a 1% annual return on your savings, which would then be chewed up by inflation.
But there is a solution. One of Bill Clinton's legacies in the United States is i bonds, or inflation bonds -- tax-deferred, inflation indexed savings bonds.
A grassroots campaign to bring i bonds to Canada is picking up steam, but Canadian policy-makers seem lukewarm to the idea.
Jacqueline Orange, president of Canada Investment and Savings, says she hasn't seen a huge demand for I Bonds, though she concedes that could be because the average investor is unaware of the benefits.
She says the government already sells real-return bonds at the wholesale level, but that any question of tax deferment rests with the Department of Finance.
Canada's tax system is based on ability to pay. Exceptions are made to attain specific social or other policy objectives (such as RRSPs), but these require the government to forgo revenue. Cuts in general tax rates have also reduced the tax burden on savings.
Those who want to see I Bonds in Canada should "make their views known" to consultations conducted by the House of Commons Committee on Finance, a process that provides input to the federal budget, he said.
Canada Savings Bonds offer 'negative real rate of return'|
Jonathan Chevreau • The National Post • October 6, 2001
Canada Savings Bonds issued this autumn will pay an annual rate of 1.8%, their lowest -- so low that investors may have a negative annual return if current inflation trends hold.
The lowest previous rate paid was 2.75% in 1946, the year Canada Savings Bonds were introduced, said Jacqueline Orange, president of Canada Investment and Savings (CI&S), the federal government's retail debt agency.
Based on August's annual inflation rate of 2.3%, investors will wind up with "a negative real rate of return," said Anthony Imvesi, investment analyst for Toronto-based AIM Funds Management Inc. "After paying taxes and deducting inflation, you won't get much."
Led by the U.S. Federal Reserve, central banks around the world have been repeatedly dropping interest rates in an attempt to stimulate the economy.
With the 18-month-old bear market in stocks, CI&S expects a banner sales campaign for the virtually risk-free savings bonds. The new Canada Savings Bond series 72 goes on sale on Tuesday. The advertising campaign uses the slogan, "The way to save. Guaranteed."
For those willing to lock up their money for three years, Canada Premium Bonds pay 2.3% in the first year, 2.8% in the second, and 4% in the third year, for an average 3.03%. They can be redeemed only once a year, while the regular bonds can be cashed in at any time.
This compares to a 2.97% rate for 90-day treasury bills and 2.9% for money market mutual funds, Mr. Imvesi said. Most new fund sales across the industry are flowing into money market funds, although short-term bond funds pay better.
Ms. Orange said the rates on the bonds are competitive with other similar fixed-income securities. "We have been a low interest rate and low inflation economy for some time now," she said. "With the savings bonds, it's worth remembering that the rate will never go down, so you have that downside protection," she said. "But if interest rates start to go up we will raise the rate if market conditions warrant, and we have done so in the past."
Internet chat forums were quick to denounce the new Canada Savings Bond rates. "Considering that ING now pays about 3.5% for cash, many GICs are available in the 3.5% to 5% range, why would anyone buy these puppies?" asked a Web participant who goes by the handle Bylo Selhi.
Real-return 30-year Canadian bonds in the wholesale market pay 5.99% Some do-it-yourself investors are lobbying CI&S to introduce tax-effective, inflation indexed bonds called Inflation Bonds, which already exist in the United States.
Safe, secure CSBs not so dull any more|
Jonathan Chevreau • The National Post • September 27, 2001
The federal government's retail debt agency expects the deepening global bear market will lead to one of the most successful Canada Savings Bonds sales campaigns in years.
Although interest rates have tumbled and the next series of CSBs will barely beat the rate of inflation, Canada Investment and Savings (CI&S) expects investors to flock to the bonds as at least initial principal will be guaranteed.
"When the stock market returned double digits, the thought of a safe, secure return in the lower single digits wasn't attractive," says Jackie Orange, CI&S president and CEO. "Forgotten in all this was the guarantee of principal. This has become a lead attraction although interest rates continue to be low and may be lower."
One of the best years for CSBs was the $17-billion in gross sales they enjoyed after the October, 1987, stock market meltdown.
The annual fall ritual kicks off Monday, Oct. 1. but it's no longer restricted to a one-month sales window. As has been the case since 1998, the sales season will have a six-month window, extending until April 1, 2002.
The experimental extended six-month sales period is now a permanent feature, says Orange. She would not say how much interest the new bonds will pay. Rates will not be announced until shortly before the issue date because of changing market conditions.
The last time the bonds were on sale, in April 2001, the cashable CSBs were paying just 3.65%. The less liquid Canada Premium Bonds (CPBs, which can be cashed only once in the year) normally pay a quarter to a half percentage point better and have an escalating payout over three years. Thus, the last series paid 4.35% in year one, 4.45% in year two and 4.45% in year three, for a compound rate of 4.44% if held over three years.
Also new this year is that investors will be able to purchase bonds directly from the government over the Internet by accessing www.csb.gc.ca., an extension of the option introduced last year of buying CSBs and CPBs by telephone.
Those who want to buy CSBs or CPBs for their registered retirement savings plan can do so through The Canada RSP, an innovation in place since 1995. This is no fee for this. As with regular RRSPs, the contribution is tax deductible. The minimum purchase under this option is $500. Similarly, there is a RRIF option to hold these bonds inside registered retirement income funds.
Earlier investments made within The Canada RSP can be exchanged. You can redeem an old series and buy a new issue within the six-month sales campaign window.
You can also cash out of a Canada RSP but tax will be withheld from the proceeds, which must be claimed as income in the year in which it is received.
Thus far neither CSBs nor CPBs are indexed to inflation, as are real return bonds. Orange says the agency has a watching brief on this, but because inflation has been low it has perceived no real demand from the 1.5 million Canadians who purchase CSBs every year.
"Real return bonds have a place and we do have them in the Canadian government at the wholesale level. We were leaders in that. When demand changes of course we'd take a look at a good retail product" that was indexed to inflation.
Apart from lack of inflation indexing, another problem CSBs share with other fixed income investments outside an RRSP is taxation.
Since 1990 interest earned on all both the R (regular interest) and C (compound interest) bonds above Series 44 must be declared annually in the year in which it is earned. That interest is taxed like earned income at the top marginal tax rate.
In the United States, there is a product CI&S would be well advised to imitate: Inflation Bonds, which get around both the tax and inflation problems. Orange said she is aware of a grass roots petition to introduce I Bonds in Canada but that the tax policy part of the equation has to be addressed to the Department of Finance.
Cut us some slack, Ottawa, with I Bonds|
Jonathan Chevreau • The National Post • September 1, 2001
Web campaign demands alternative to savings bonds
While Members of Parliament took the summer off and enjoyed the 20% pay raise they granted themselves, small investors were launching a grassroots campaign to convince Ottawa to introduce a bear-market-proof savings bond that fights both inflation and taxation.
So-called I Bonds, or inflation bonds, are inflation-indexed, tax-deferred bonds. They exist in the United States, although a precursor to them originated in Canada.
Over the past few weeks, a group of do-it-yourself investors, mostly in British Columbia and Ontario, launched a campaign to bring I Bonds to Canada, creating a Web site with a petition that lets Canadians vote for the suggestions and send their thoughts to Paul Martin, the Finance Minister.
The group is not affiliated with members of the financial services industry, although some, like Vancouver-based fee-only advisor Terry Greene, have been among the first people to sign the petition. The campaign has also attracted the support of former securities regulator Glorianne Stromberg, who believes I Bonds should be introduced in Canada along with higher RRSP contribution limits and tax-prepaid savings plans, or TPSPs. I support I Bonds as well and have added my John Hancock -- or should I say John Chevreau -- to the petition.
Unlike the long-term retirement focus of those products, the Canadian I Bond campaign would help ordinary Canadians save money outside registered plans for short-term goals. These might include their children's education, a down payment for a first home and an emergency fund in case of a job loss or medical problems.
The problem with current federal policy is that Canadians are forced to take on more risk than necessary with their non-registered savings. The Income Tax Act unfairly taxes safe fixed-income investments and thereby tempts many short-term savers to risk their capital in the stock market. That bet has turned sour for many in the current bear market. In the year up to July 31, the Toronto Stock Exchange 300 index has lost about 24%.
If investors want to preserve capital through traditional interest-bearing investments like bank accounts or savings bonds, they face a triple whammy. First, they pay tax on the original income to create the nest egg in the first place. What's left goes into a savings vehicle, which generates a modest amount of income, which is taxed again just as heavily as income. And finally, over the long term, what capital remains steadily loses ground to inflation.
For people in the top tax bracket, that means a tax rate of 46% on such investments as government or corporate bonds, cash held in daily interest savings accounts or even dividends from non-Canadian corporations.
You can cut that tax in half, and stand a better chance of beating inflation, by accepting more risk and investing in stocks or equity mutual funds. The tax advantage of equities over fixed income became greater still when Ottawa cut the capital gains inclusion rate to 50% from 75%. As a result, even in the top tax bracket capital gains on stocks are taxed at about 23% -- less than Canadian dividend income and about half the rate on interest income.
That's why I Bonds are such an appealing idea.
In the United States, I Bonds defer taxes on the interest for up to 30 years. Moreover, they can be held outside registered plans without incurring tax until redeemed.
The first good I Bond feature, inflation indexing, was inspired by Canadian-developed real return bonds. With these, the real rate is fixed at, say, 3.5%, then the prevailing inflation adjustment is added to provide the total return. So if you had a 3.5% real rate and inflation at 3% for a particular year, you would have earned 6.5% in total with a real return bond.
However, real return bonds aren't widely available through most Canadian financial advisors. The market is thin and the commissions high.
But that problem doesn't exist in the United States because the government there made the vehicle accessible to all. In 1997, the U.S. Treasury Departm Canadian government; there is no currency or nominal interest rate risk; they offer low volatility; and they are not tied to the fortunes of the stock market and only slightly to the regular bond market. You would be able to invest as little as $50 or as much as $30,000 a year, and redeem at any time (but with tax consequences at that point).
The pressing need is to have a safe investment that keeps up with inflation, but I Bonds would not lose money in the event of deflation, either.
If you'd like to bring I Bonds to Canada, go to the Web site (http://canadianinvestor.tripod.com/) and sign the petition. Of course, it won't mean that Ottawa will give the rest of us instant 20% raises, but I Bonds would at least provide a decent return on the after-tax income we do manage to put aside.
It's the least Ottawa can do.