Steady retirement income, tax savings and philanthropy all in one mutual fund.
Many investors are interested in products that can help generate a reliable stream of retirement income with the added benefit of some tax-efficient strategies, and that makes Series T mutual funds worth a closer look.
This distinct type of mutual fund offers a tax-efficient stream of monthly income during retirement and can reduce the clawback of income-tested benefits, such as Old Age Security (OAS) payments.
Paying taxes is a fact of life – but it’s also a fact that some investments make a point of using tax rules to enable people to do more with their money and still meet their tax responsibilities.
Series T mutual funds are all about gaining systemic, tax-efficient income from monthly distributions and sidelining the capital gains from monthly withdrawals. Since the distributions are classed as part of the principal and paid out as a return of capital (ROC), they are tax-free. Moreover, when a Series T fund holder takes income from the investment during retirement, that income does not impact OAS, which is income-tested and may be clawed back by the government if their retirement income is too high in any given year.
After the full amount of the initial investment has been dispensed as ROC over the years, a few effective tax strategies can come into effect. For example, income from the remainder of the investment is taxed as capital gains, which is applied at a 50 per cent inclusion rate, half the rate at which interest income is currently taxed.
Capitalizing on client appeal
When you line up all the advantages of a Series T mutual fund investment, a profile of a particular kind of investor begins to emerge. This type of fund generally appeals to investors who are interested in maximizing their retirement income without it affecting their income-tested benefits. These individuals may already be taking Retirement Income Fund (RIF) payments and looking to increase their monthly income. But more than that, this type of investment resonates with people who are planning to donate a significant amount of money to charities they support.
When donating funds to a charity, the sale of publicly traded securities such as stocks, bonds, mutual funds, and segregated fund contracts requires that the donor pay tax on 50 per cent of the capital gains achieved from the assets’ appreciation in value. However, a special government incentive program offers a significant advantage when donating publicly traded securities – the capital gains inclusion rate is reduced to zero per cent. This means the tax on any capital gains from the disposition of publicly traded securities donated directly to a charity is eliminated, incurring substantial tax savings.¹
Using these charitable gifting rules in combination with a Series T mutual fund can help owners generate tax-efficient income and eliminate the capital gains tax on their donation. By transferring ownership of some or all these mutual funds to charity, clients can take advantage of the zero per cent inclusion rate, eliminating the capital gains tax, while receiving tax savings from the donation. In effect, the tax that would have been paid to the Canada Revenue Agency (CRA) is redirected to the charity.
How it all works
Investments are designed to appeal to clients based on a range of attractive criteria – and there’s a lot to consider when weighing the advantages of investing in a Series T mutual fund. There are benefits that clearly work in the investor’s favour, as illustrated in this example:
Fifty-five-year-old Pat, who recently retired, wants to receive a sustainable, tax-efficient income from $200,000 of savings. The goal is to keep the $200,000 at or slightly above this amount until a later time, when Pat wishes to donate a sizeable portion to charity.
If Pat invests $200,000 in a Series T fund that generates six per cent in annual cash flow, it will provide an average after-tax income of $11,400 for 19 years.² The total received over that period is $216,600, after tax. At that point, the adjusted cost base will reach zero.
With a six per cent annual rate of return, Pat’s account will still be worth $200,000. If Pat cashes out the investment, taxes owing on the full $200,000 capital gain will generate $40,000 in additional taxes.
Pat now needs to decide on one of the following options:
- Maintain the investment and stop receiving ROC distributions altogether
- Continue with future ROC distributions that will be less tax-efficient
- Donate the funds to charity
Pat decides to transfer ownership of $67,000 of the portfolio to a registered charity.
The capital gain realized on the transferred amount won’t be taxed and a $67,000 charitable donation receipt will be issued, providing a tax credit equal to about $26,800 (depending on the province).
Pat now removes the remaining $133,000 from the Series T fund, and offsets the tax of $26,600 on the capital gain with the credit for the charitable donation.
The strategy allows Pat to earn annual tax-efficient income and to donate a sizeable sum to charity without incurring any tax on capital gains. The amount that would have been paid as tax to the CRA has instead been redirected to Pat’s charity of choice.
Series T mutual funds are generally chosen for their track record of giving investors the opportunity to draw a steady income stream for a significant length of time. Given how they differ in some unique ways from other types of mutual fund investments, a Series T mutual fund could be the right product for some of your clients who are pondering their retirement income options. For more information, refer to this online brochure, or watch these helpful videos: How Series T Funds work, Generating Tax Efficient Income and When the Adjusted Cost Base equals zero.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Manulife Funds are managed by Manulife Investment Management Limited (formerly named Manulife Asset Management Limited). Manulife Investment Management is a trade name of Manulife Investment Management Limited.
- This applies to direct donations to a charity (or donations in kind) while alive. If a direct donation occurs at death, a zero capital gains inclusion rate will only apply if the donation qualifies as a gift from a Graduated Rate Estate (GRE).
- Assumes six per cent annual rate of return, a marginal tax rate of 40 per cent, taxable distributions of $1,500 per year and ROC distributions of $10,500 per year. For illustration purposes only.