Every day, more than a thousand Canadian boomers turn 65. The trend is expected to continue for the next 17 years.
And as they enter into the drawdown period, they’re looking for ways to turn their nest eggs into retirement income.
This has resulted in the need to fundamentally shift their asset mixes, Rick Headrick, president of Sun Life Global Investments, told a lunchtime audience at an advisor event recently.
“In 2000, 70% of portfolio holdings were sitting in equities, [while only] 14% were in the income categories,” he says. “Today 44% is [allocated to] fixed income.”
The other major investment trend, he adds, is corporate-class bonds. For non-registered assets, it’s a tax-efficient way to draw income out. In fact, last year, the bulk of net flows into corporate class were allocated to fixed income.
So for all the talk of the great rotation into equities, current flows suggest if there’s any rotation, it’s into fixed income.
“Equity funds have been in net redemption each of the last four years,” says Headrick. “Certainly there’s been a flight to safety as well, but it’s also because of that thirst for yield.”
Corporate class’ first major advantage is the ability to switch between funds within the structure.
“If you wanted to trim your Canadian equity weighting, and move more into emerging markets, you could do that within corporate class without triggering a tax event,” says Headrick.
Another big advantage: efficient taxable distributions. A corporate mutual fund company can pay out Canadian dividends, which are taxed more favourably than interest income or foreign dividends. Also, on redemption, only 50% of capital gains are taxable.
The structure can cancel out gains and losses for tax purposes.
“If you have one fund sitting in a gain position and another in loss, they offset each other,” says Headrick.
But these advantages come at a cost.
“Corporate class fixed-income funds have higher fees relative to the mutual fund trust version,” he says. “But that’s ok because tax efficiencies more than offset those higher fees.”
Another potential negative is the double taxation on interest and foreign income due to fund-level taxation.
“If it’s income interest from a bond fund or dividends from U.S. equity funds, it gets taxed within that corporation and then taxed again when it comes out,” says Headrick. “What investment managers have been doing [to circumvent that] is entering into forward agreements to convert income from interest [and] foreign dividends into Canadian dividends.”
However, the Department of Finance is now preventing funds from converting distributions with the purpose of lowering taxable returns.
“The idea of taking all of clients’ non-registered assets and putting them into corporate class doesn’t hold true anymore,” says Headrick. “An investor will be better off keeping fixed-income investments within a mutual fund trust to avoid double taxation. Further, the strategy of keeping such assets inside an RRSP or TFSA and allocating Canadian equities to non-registered investments within a corporate class structure became even more compelling post-budget.”
Headrick notes another wrinkle in the form of the disconnect between investors’ risk appetite and their return expectations.
“Only 22% of your clients are willing to take on more risk to get a higher return, yet 40% expect their investments to yield 5% to 7%, he says.
That means the traditional asset mix of fixed income and Canadian equities won’t cut it.
“Investors need to diversify into infrastructure (toll roads, airports, etc.), real estate, emerging market debt and other non-traditional asset classes to create sustainable income in retirement,” he asserts.