Anthony Tobias
For Business Edge
The demise of the capital gains exemption has made capital gains a factor for all investors.
Many investors will spend both time and effort fine-tuning their RSP portfolio by switching from one mutual fund to another.
However, applying these practices in non-registered accounts can cause exposure to unwanted taxation.
Deferring the payment of tax is usually a good strategy to maximize investment performance. That way, you can continue to invest all your money for your own benefit — including money that would otherwise have been paid out in taxes.
That is the principle which makes RSP investing so powerful. The real benefit of an RSP is not the immediate tax-deduction, but it is the growth generated from tax-deferred compounding. When taxes are not subtracted from your invested money, growth at the same rate results in larger gains.
So how can an investor remain active in a non-registered portfolio without losing compounding power to taxes?
It would be ideal to have a non-registered portfolio that could act like an RSP — allowing both rebalancing and diversification while still deferring capital gains. The answer? A mutual fund corporation.
Investing within a mutual fund corporation allows shareholders to switch their shares from one class to another without realizing a taxable gain at the time of switch. The switch is not considered to be a “deemed disposition’” or a taxable event — as it would be when switching your investment between individual mutual funds outside the mutual fund corporation.
This allows you to make changes in your personal portfolio without income tax concerns. You can re-balance your portfolio or make transfers to take advantage of market conditions.
Remaining inside a mutual fund corporation and sheltering capital gains can offer valuable benefits for investors. Long-term tax deferred compounding is very powerful. Let’s look at an example of a $10,000 investment compounded at 12 per cent annually and subject to 40 per cent tax.
If you held this investment for 30 years, and then paid tax, your after-tax value would be $183,760 compared to just $80,509 if the same investment were taxed annually.
Many major mutual companies here in Canada offer the availability to invest in the class shares of mutual fund corporations. These include: AIC Funds, AIM Funds, Mackenzie Financial, Synergy Funds and the pioneers in this field, CI Funds. With this vast array of choices, investors can lock in gains while diversifying among world regions and economic sectors.
It is important to note that mutual fund corporation investing is tax-deferred, not tax-exempt.
This being known, the decision to invest in a mutual fund corporation should not be based solely on tax considerations. Rather, it should be based on the merits of the investment, and its suitability to the objectives and risk tolerance of the investor.
Anthony Tobias is branch manager with Great Western Financial Corporation in Calgary. These ideas are those of Anthony Tobias and do not necessarily reflect those ideas of Great Western Financial Corporation. Mutual funds are not guaranteed, their values will change and past performance may not be repeated. Read the prospectus before investing.
