Mutual Fund Corporations

Last week, I wrote about the benefits of Mutual Fund Corporations over mutual fund trusts. This article obviously touched a soft spot in Canadians as I received many questions and comments on the topic; so much so that I decided to write this follow-up article.

Starting with the basics – Deduct, Defer, Divide

Proper tax planning starts with the basics, what I call the three D's of tax – Deduct, Divide and Defer.

Mutual Fund Corporations are products that benefit from a TAX DEFERAL strategy. Most often it is better to pay a dollar of tax later than it is to pay it today. While that is not always the case, deferral of tax can make a significant difference over time.

Tax deferral DOES make a difference

Let's pretend that I have a twin sister named Irene. We are the same age and we are in the same marginal tax bracket. We each inherit $10,000 and plan to invest that $10,000 in mutual funds. Let's assume that Irene and I both invest in the exact same mutual funds except that Irene decides to invest in a mutual fund corporation and I invest in mutual fund trusts.

Let's also assume that we trade our mutual funds regularly (every year). Regardless of whether trading is the right strategy or not, let's assume that once a year we make changes to the portfolio. It might be to rebalance, to take profits or simply to get rid of losers.

Irene and I have the same investments and the same strategy to manage our funds and the only difference in our two portfolios is my portfolio is classified as a trust and Irene's portfolio is classified as a corporation. Does this make a difference?

The results are in

Let's assume that we make 10% per year, and all of the return is in the form of capital gains (as opposed to interest or dividends). Let's further assume that our marginal tax rate is 36% (federal and provincial combined).

After 10 years, Irene has $25,937 in her investment account. For me, my account did not fare as well because I paid tax every year as a result of trading. My account, after paying the tax, only grew to $20,779. That's a big difference! To make things fair, Irene has to eventually pay the tax (Mutual Fund Corporations defer tax but does not avoid them). If Irene were to cash out the funds in the 10th year and pay the tax, she would still have $22,093 which is still $1314 more than me.

The longer the time frame, the more significant the difference. After 20 years, Irene has $53,460 (after paying the tax) while I only have $43,179. That's a 23% difference in assets.

Why the difference?

Simple. The difference is taxes and the compounding growth of the tax deferral. Most experts will agree that while most Canadians buy an RRSP for the tax deduction, the tax deferral of the growth is the more significant benefit over time. Tax deferral, whether RRSP or non-RRSP, allows you to use government money to make more money.

Investors with non-RRSP assets, concerned about paying taxes and desire the ability to make changes rather than adopt a pure buy and hold strategy should consider the benefits of Mutual Fund Corporations.

While the cost on these funds can be a little higher than the average mutual fund, the tax benefits may far outweigh the costs.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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