Interested in More Income AND Less Tax?
Written by Chris Karram
Receiving cash flow from your investments is great. However, receiving tax efficient cash flow is even better!
For most retired Canadians, the income they earn from their investment portfolio often provides a positive result in the way of cash flow or income. However, there are also the potential drawbacks that cannot be overlooked. On the one hand, the income they receive helps to supplement their RRSP, RRIF or pension plan, which for most people is a great thing. On the other hand, this income is usually taxed at a high rate, or quite often very unpredictable.
What if there was a way to create sustainable and tax efficient cash flow?
The Issue at Hand
Until recently the only answer to the question above was to invest in a GIC, annuity or even the market. All of these options had their down side however. If the income was consistent, the return was usually very small. If the income was tax efficient, the risk and predictability was far from consistent. If both the income was predictable and the cash flow tax efficient, the liquidity simply did not exist.
The only other answer was to do what most mutual fund companies have already done and thus create a product called T Series mutual funds. These types of funds are also referred to as ROC or T-SWYP mutual funds, depending on the company of choice.
How T Series Mutual Funds Work
These funds make monthly distributions to their investors, but they do so in the form of a “Return of Capital”. This capital represents unrealized gains in your investment or the return of your original investment. Not only is this distribution not taxable, but the new found cash flow is tax deferred until the fund’s units are sold or the investors capital is depleted. Generally, the investor has the ability to choose between a 4% and 8% distribution, depending on the company of choice.
With each return of capital distribution, the adjusted cost base (ACB) of the fund is lowered which will eventually lead to a realized gain that is then subject to tax. The primary benefit is that the tax on the capital gain has been largely or even sometimes entirely deferred. This provides the investor with the ability to control when they wish to incur the tax liability, which is most often at the time the investor is in a much lower tax bracket.
Who Can Benefit from T Series Mutual Funds
T Series mutual funds can benefit almost anyone, and can be used in multiple different ways. In most cases however, these funds can benefit Canadians who are looking too:
- Maintain the liquidity of their income producing investment portfolio
- Collect Income that does not trigger a potential Old Age Security clawbac
- Create a tax efficient income source apart from their RRSP or RRIF payments
- Draw an income from their portfolio while maintaining the potential for growth through exposure to equities
What’s in It for Me?
Let’s assume that an individual invests $100,000 into a T Series mutual fund portfolio that averages a rate of return of 7.70%. The age of this particular person is of no consequence, but we do know that he or she is currently in a 46.41% tax bracket.
If we look at this person’s situation twenty years later, they have benefited by:
- A total after tax total cash flow of $134,065
- An average annual after tax cash flow of $6,703
- A total tax bill of $10,293
- An average annual tax bill of only $514
- An effective annual tax rate of just 7.13%
Considering that a traditional interest income bearing investment would create a total tax bill of $46,410 in this same situation, it is easy to identify the very real tax savings that are available. This mutual fund product can unquestionably make a substantial difference for both the investor, and their heirs.
This product and strategy is by no means a “One Size Fits All” solution, and it is not something that will fit for each and every situation. The only question to ask yourself is “Is it worth it to at least explore whether this income producing investment vehicle is right for me?”
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