I recently found out one of the country’s largest advisory teams isn’t offering mutual fund corporation structures, or corporate-class funds, to clients.
Even though these structures are more tax-efficient, these advisors simply sell investments without considering tax planning.
I shouldn’t be surprised. There are more than $850 billion in mutual funds nationally, but only $59 billion is in corporate-class structures. Yet there are many advantages to using such structures, especially for retirees needing income.
What are corporate-class funds?
Think of a mutual fund corporation as an umbrella structure under which you hold various mutual funds. Mutual funds can be bought and sold within the umbrella and as long as the assets do not leave the corporation, there is no deemed disposition — hence no tax payable. This has been the common use of mutual fund corporations.
Benefits for boomers
There are other benefits of the corporate-class structure for boomers.
1. Conversion of interest income to capital gains. In a mutual fund corporation, where all products within the umbrella can share costs, income, and gains, tax-inefficient interest income can be converted into tax-efficient dividends and/or capital gains.
This could reduce the tax payable by your client in the short term by almost half. In the best-case scenario, it will eliminate any immediate taxes payable if the client has capital losses they can write off against the gains.
2. Dividends from foreign issuers. As the momentum behind U.S. stocks starts to build, more and more investors will be receiving U.S. dividends. Since U.S. companies do not pay tax in Canada, the income received by Canadians is treated as foreign income rather than dividends.
To avoid the additional tax burden of this, a corporate-class structure can convert foreign income into capital gains. This gives investors additional freedom to buy dividend-paying U.S. and foreign equities and still receive favourable tax treatment on the distributions.
3. OAS clawback. A large number of Canadians have been paying into CPP and OAS their whole lives through deductions from income. Unfortunately, the government claws back those benefits when a couple’s income exceeds $66,000.
While we can’t eliminate the clawback, a corporate-class fund lets us reduce it by taking any income and converting it to capital gains. That reduces the income declared.
Tax-advantaged investing has never been more important to an advisor’s business than it is today. With exceptionally low interest rates, and more baby boomers entering retirement every day, the traditional tax planning tenets of deduct, defer and divide have become far more complex.
While I would never advocate making any investment decision simply on tax merits, with mutual fund corporations, we can now add “convert” as one more tax-planning consideration.