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HOW 'T-SERIES' MUTUAL FUNDS WORK
10/20/2017 8:36:50 AM
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Fund Library Q&A
Your questions about financial planning, investments, and portfolio management answered by an industry expert



By Robyn K. Thompson  | Friday, May 23, 2014


Q – As a new retiree, I’ve been looking for ways to secure a regular income stream. I spoke with a financial planner at my local bank, and she suggested putting some of my non-registered investments into one of the bank’s “T6-series” mutual fund, which pays out a 6% annualized distribution, paid monthly, which she says is “tax efficient.” She mentioned “return of capital” and “tax-free switching” among other things. But I’m not quite sure how this works. Can you explain? – Fred R., Scarborough, Ontario

A – “T series” funds, named because they are supposedly “tax efficient,” have become a popular type of mutual fund for investors seeking a steady, high annual cash payout, in this case a 6% annual distribution rate. Now, most funds do not produce enough income to pay out 6% distribution.

So the T-series fund accomplishes the 6% distribution rate not by selling units as you would in a Systematic Withdrawal Plan (SWP), but by giving you your own money back as a large percentage of each monthly payment. That portion, called “return of capital,” is not taxable, for the very simple reason that it’s your own invested capital, presumably on which you’ve already paid tax.

Any interest, dividends, or capital gain received as part of the distribution would still be taxable, but it’s typically only a fraction of the total monthly distribution you receive. The tax-efficiency part of it relates to that portion of the investment that continues to grow within the fund on a tax-deferred basis.

Each return-of-capital payment reduces the adjusted cost base (ACB) of your investment. Your ACB could conceivably fall to zero once all your invested capital has been returned to you. After that, any further return of capital distributions will then be treated as capital gains (because you are now getting back more than you originally invested), half of which you must include as taxable income. And when you eventually sell your fund, a zero ACB means you could have a bigger taxable capital gain or a smaller capital loss, depending on the performance of the fund.

In addition, T-series funds under a “corporate class” umbrella let you switch between funds under the same umbrella without triggering a capital gain.

Remember that T-series funds are in fact mutual fund investments – that’s easy to forget when you get wrapped up in distribution rates, return of capital, and adjusted cost base calculations. That means there’s an element of risk involved. Mutual funds, except for segregated funds, are not guaranteed. Performance of T-series funds will vary, as they do with any other mutual fund.

So if you’re considering a T-series fund, pay close attention to both the payout rate and the fund performance to ensure that the distribution rate will be sustainable.

If a fund’s income from investments (interest, dividends, capital gains) is less than what it pays out in cash, it has to come up with the money by bringing in new investors, selling existing investments, borrowing, or increasing cash allocation. Ultimately, a poorly-performing T-series fund may have to cut distributions, which will certainly squeeze those investors who have been using the distributions to fund living expenses.

T-series funds are just one option for creating a retirement income stream – and not necessarily the best one. Other choices might include a mixture of annuity strategies, systematic withdrawal plans from regular mutual funds, segregated funds, and RRSP/RRIF maturity strategies. A Certified Financial Planner can help cut through the confusion, and devise the mix of retirement income vehicles that best suits your needs. – Robyn

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Submit a question on investments, financial planning, or portfolio management. We cannot reply personally and cannot guarantee your question will be used.

Notes and Disclaimer

© 2014 by the Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.

 
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