facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause

Give to yourself now, and to charity later

Series T mutual funds provide significant tax benefits. 

Many people are looking for ways to generate tax-efficient income in retirement. Some also want to create a charitable legacy by donating a substantial gift to a favourite cause. Series T mutual funds can help achieve both goals through a single investment solution.

What sets Series T mutual funds apart is that they distribute mostly return of capital (ROC) for as long as they can, keeping almost all investment growth within the fund. ROC is the principal you originally invested, which means you receive it tax-free. In addition, because ROC doesn’t count as taxable income, it doesn’t affect income-tested benefits such as Old Age Security (OAS) and the Age Credit. 

After all the original investment has been distributed, the other ROC distributions from a Series T mutual fund are taxed as capital gains. That’s still attractive from a tax perspective, because only 50 per cent of the capital gains you earn are taxable at your marginal tax rate. However, when you begin to receive it, this income may start to affect money received from OAS.

One option to avoid tax on the money that remains in the Series T mutual fund is to donate some of it to charity. No capital gains tax is due when securities are donated directly to a registered charity while the donor is alive, and the resulting charitable donation receipt can offset the capital gains tax that results from cashing out the rest of the investment.

This strategy provides both a period of tax-efficient income and the opportunity to make a sizeable donation to charity that reduces or eliminates taxes that would otherwise have to be paid. 

A typical example This case study helps explain how it all works.   Pat, who recently retired at age 55, wants to generate income from $200,000 saved in a non-registered account. She has other income that puts her close to the limit beyond which OAS clawbacks start, so she chooses to invest the $200,000 in a Series T mutual fund that generates six per cent in annual cash flow.   For the next 19 years, she receives $10,500 in ROC distributions and $1,500 in taxable distributions annually. If her marginal tax rate is 40 per cent and the fund performs as expected, she will receive a total of $11,400 in after-tax income from this investment every year. The $10,500 in ROC distributions are entirely tax-free and don’t in any way affect her OAS payments.   A variety of options   Assuming the fund has an annual rate of return of six per cent, the market value of Pat’s investment is still $200,000. But now the fund has paid out all of Pat’s original investment and the adjusted cost base (ACB) is zero.   Option 1: She can withdraw the money, in which case the entire $200,000 is taxable as capital gains. With her marginal tax rate of 40 per cent, she will owe $40,000 in taxes.  Option 2: She doesn’t have to withdraw everything, of course. She can stop the distributions and continue to grow her investment. Or she can continue to receive distributions and pay capital gains tax on $10,500 of that income, plus the tax she always paid on $1,500 in taxable distributions, for a total of $2,700 in tax each year.   Option 3: She can donate enough of the money to charity to offset the taxes she owes on the rest – which she can then withdraw and reinvest in any way she wants.  Pat decides on the third option. She transfers ownership of fund units worth $67,000 to her favourite registered charity. Depending on her province, she will get a tax credit of about $26,800. Now she can withdraw the remaining $133,000, and the resulting capital gains tax of $26,600 will be more than offset by the tax credit.  In the end, Pat gets a steady stream of tax-efficient income for 19 years, makes a legacy-building donation, and pays no capital gains tax.   For illustration purposes only

Speak with your advisor

Your advisor can help you decide whether this strategy makes sense for you. In general, it’s worth considering if you need a source of tax-efficient income from investments in a non-registered account and are interested in minimizing taxes so you can maximize a philanthropic donation. Ask your advisor to explain the pros and cons of incorporating Series T mutual funds into your financial plan. 

Financial Advisor Websites by Twenty Over Ten Powered by Twenty Over Ten