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Discussion Starter #1
I am trying to understand an investment scheme my mother-in-law is involved in that was recommended by her advisor. Her funds are invested in several mutual funds. Each month some of the units are sold in order to generate a monthly cash payment. The payments are apparently considered to be tax efficient because they mainly represent return of capital.

I'm sure this is a common strategy, but I need to understand the tax consequences in the future. I'm happy to do the research, but I'm not sure what this type of plan is called.

Can anyone give me a term to Google?

Thanks,
Russ
 

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I'm not totally sure what concept you want to google, but here are some thoughts:

Here is a basic article on the taxation of mutual funds in Canada.

The process of selling a fluctuating number of units periodically in order to generate income is typically known (in the financial services industry) as a SWiP arrangement - for Systemic Withdrawal Plan.

So, it sounds like your mom's advisor has set up a SWiP using (notionally) tax-efficient mutual funds (that have a return of capital component).

I wouldn't necessarily call this an investment "scheme." This is a common way to provide tax-efficient income streams from a portfolio. It is a way to provide a level monthly (or quarterly) income stream from a fluctuating portfolio.

You may have questions about the particular mutual funds. However, lots of different investments have a return of capital feature.

Does that help?
 

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It can usually be done two ways. The first and oldest is the systematic withdrawal plan (SWP), where units are sold to make up the amount of monthly income the investor requests. The second are the new T-class funds that payout a dividend equal to some pre-determined amount. Example 5% or 8% or even 10%. The T-class funds (T stands for tax efficient, I think) will have 13 monthly distributions. 12 regular that will be all ROC and 1 more at the end of the year to encompass all the interest, dividends and capital gains the fund has received whose tax consequences need to be flowed through to the investor.

At no time do the funds guarantee that the withdrawal or capital value can be maintained and in bad markets you see them lowering the dividend all the time.

I think the 2nd method is a lot easier to deal with from a tax perspective, because the old SWP required an actual sale, 12 times within the year, and although the tax implecations were small, the investor still had to deal with all those capital dispositions on their taxes, regardless. It would be a real accounting hassle, in my opinion. The T-class funds allowed the investor to at least defer all the capital gain/loss issues until they moved out of the investment entirely.
 

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Discussion Starter #4
Thanks - this will get me started. This particular plan is a SWP type I'm pretty sure. And yes, it seems to me keeping track of the unit sales and re-investments will be very complicated.

This is not a new plan and I suspect the tax and cost base calculations have not been tracked for several years. My mother-in-law is over 80 and is not well versed in financial matters. Her deceased husband knew enough to be dangerous.

Thanks for your help.
 

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With a simple SWP you can see the effect of the capital withdrawal because the net asset value of the account goes down. Any realized capital gains on the sale of units are "pay-as-you-go", they are taxed in the current year.

But there are also a number of so-called "tax advantaged", or "tax-efficient" monthly income funds around now that are specifically structured to include "Returns of Capital" (ROC) in their distributions, rather than just earnings. ROC reduces the ACB of these funds. What this does is defer taxable capital gains on these funds until they are sold (or disposed of as part of the estate.)

With these new types of funds you may only see a drop in the "book value" or "average purchase cost" on the statements, but not the net asset value.
 

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If units are in fact being sold, it is a systematic withdrawal plan where a number of units are sold in order to put a set dollar amount into your account. If the funds are paying monthly cash distributions, then you have what might be a portfolio of T-series funds. See this discussion on T-series funds.
 

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Discussion Starter #7
This particular account appears to be a SWP, not a T-SWP. The account currently holds seven mutual funds (all but one are DSC type). Fund distributions are reinvested in the fund, and units of one fund are sold to generate the monthly cash payments.

Going back in time to calculate the ACB will be tricky. Hopefully there will not be any significant tax liabilities arising out of this exercise. The odd thing is, the monthly income is not actually needed. It looks like an unduly complicated setup that achieves something the account holder doesn't particularly need.

Russ
 
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