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Tax Efficient Investing

London Free Press

Half of all Canadians invest outside their RRSP in a “non-registered” or “open” account but are they doing it wisely? Although open accounts can get investors on track to purchase a home vacation or to create a systematic way to save for retirement, open savings investors usually focus solely on two concerns namely the volatility and the growth of their investments. Though these considerations are worthwhile one should not overlook the tax liability that investments generate in an open account. Unlike a registered account such as an RSP or a R IF, the interest income earned in an open account is taxed immediately. For example, if it’s interest income at 6 percent and you are in the top tax rate your net return is almost 3 percent and after inflation your real return on a 6 percent GIC is close to 1 percent net.

If you can create capital gains and even better find a way to defer those capital gains, you are much further off moving your interest income into an instrument that creates capital gains. The investment industry has created a new way of providing tax efficient monthly cash flow from your open accounts. Investments in the past provide a monthly cash flow called the “systematic withdrawal plan” however that can leave you with an immediate tax liability in the capital gains as units are redeemed. A new product released called “T-SWP” allows you to defer taxes until you redeem the entire investment thanks to a unique structure of it’s monthly distributions which do not require unit distributions.

A typical systematic withdrawal plan provides investors with monthly cash flow through redemptions. When you draw down unit balance, the capital gains are realized and tax is due immediately. The new T series can provide investors with monthly cash flow using a flexible distribution strategy that allows for the potential of some tax deferral. Through present monthly distributions comprised in part by non-taxable return of capital (ROC), you can receive a tax efficient cash flow each month without redeeming units and without triggering personal capital gains.

Typically, distributions from a mutual fund may contain a combination of four types of income; capital gains, dividends, interest and return of capital. While a substantial portion of the monthly distribution in “T” series is expected to be a return of capital, any taxable income and/or dividends earned by the fund will also be reflected in the distributions throughout the year. This means that any capital gains realized by the fund will be paid to the investors in a separate re-invested distribution at year-end.

By definition return of capital involves returning to the investors a portion of their own invested money. The current interest rate environment and uncertain markets has meant that the various income generating vehicles are not able to provide the high level of cash flow that many investors were accustomed to and require. The new “T”series is ideally suited for conservative, tax sensitive investors that require a steady monthly cash flow from their non-registered or open investments to supplement existing income or retirement savings. The new T-SWP series has been developed and perfected by companies such as Bissett, Clarington, Fidelity and Mackenzie. The new “T” series gives clients more flexibility in tax planning allowing them to preserve and grow capital while achieving a high level of tax efficiency.

Secondly the investment industry has created "tax class" funds. Typically, when you sell a mutual fund or stock outside an RSP you pay the deferred capital gains tax. The new "tax class" funds are structured as a corporation rather than a trust. This allows you to switch between a family of funds without triggering any capital gains.

Thirdly, several fund companies have developed treasury bill funds that are taxed as capital gain which are included into income at 50 percent rather than interest income which is included at 100 percent. This allows the security of money market but has the benefits of great tax efficiency.

These three new financial tools will assist you in reducing taxes and preserving capital.