No one likes to pay more taxes. Thankfully, there are some well-established ways for you to ease your tax burden and keep more money for yourself.
If you are actively saving for retirement it is commonly recommended to diversify your portfolio, but it is also a good idea to diversify how and when your savings will be taxed so that you can keep more money in your pocket. This tactic is especially important for small business owners and those who have maxed out their RRSP and TFSA contribution allowances.
When it comes to tax minimization, the use of a corporate class mutual fund is a strategy that can be beneficial. Before we dive into what they are, let’s take a look at what makes them a valuable asset in your portfolio:
1. Tax Efficient Growth
Simply put, corporate class mutual funds are structured in a way that allow you to defer all or most of the taxes owed while you hold the non-registered investment, leaving you with more money to compound. Key points:
- Reduce or eliminate the taxes owed while you hold the investment
- Ability to rebalance your portfolio on a regular basis without triggering capital gains or losses.
2. Tax-Efficient Income
Taxes and benefit clawbacks are one of the largest expenses that a retiree will face. But with some careful planning we can minimize the impact of these expenses in retirement.
Corporate class funds offer an attractive blend of tax-efficient income and tax-deferral benefits. When it is time to start withdrawing from the investment, the corporate class mutual fund can be combined with a T-class withdrawal program to create a greater tax efficiency. The money withdrawn provides cash flow by first returning your original non-taxable investment principal. Once all your investment principal has be paid back to you, the subsequent cash flows will be treated as capital gains and taxed at favorable rate.
In summary, you can receive tax-efficient cash flow without having to sell investments, all while deferring the taxes owed. Key Points:
- Potentially lower your taxes, as you can defer them and choose when to realize capital gains.
- To preserve or increase income-tested government benefits.
Who should invest in corporate class mutual funds?
Any investor with non-registered assets should consider Corporate Class, especially if you:
- Own a corporation
- Have maximized your tax-free savings account contributions
- Are a higher-income earner who has maximized your RRSPs
- Worried about clawbacks to your Old Age Security or other income-tested government benefits.
Owner-managed corporations
A great strategy that many owners of Canadian-controlled private corporation (CCPC) use to build up retirement savings is to invest within their corporation. If you do not require all the after-tax profits from your company for your current lifestyle, you may have the opportunity for a significant tax savings using a corporate class fund:
- Shelter the growth of your investment from the corporate passive income rules
- Taxes are minimized or deferred, leaving more money in the investment to benefit from compound growth
- Withdrawals are the form of tax-efficient capital gains or dividends
- Grow the CDA balance to facilitate a tax-free withdrawal of money from your corporation
Corporate class funds pay out primarily capital gains. Owners of a CCPC can also take advantage of this in their Capital Dividend Account (CDA). When a company has a capital gain, the untaxed half of the gain will increase the CDA balance which can be paid out as tax-free dividends to the shareholder.
Manulife has an excellent example of how this works. Click here to read more.
Additional point to ponder on: In Alberta, the 2020 Small Business Tax rate is 12.0% and the top personal tax rate is 48%. If you invest some of the retained earnings of your corporation instead of paying yourself an additional salary or dividends, the difference in taxes paid equates to 36% more money that could essentially be invested inside your corporation than what you could invest personally.
Individual Investors
Corporate class funds are also an attractive option for investors who have maxed out their RRSP and TFSA contribution room, for seniors, or for parents or grandparents setting up trusts. Utilizing a corporate class fund can:
- Create a steady stream of tax-efficient cash flow in retirement (using T-Class)
- Reducing or eliminating the Old Age Security (OAS) clawback. By supplementing income with the corporate class T class funds, retirees can get added spending power while keeping taxable income down, thus maximizing OAS.
How do Corporate Class Funds work?
To start, let’s take a step back and discuss a traditional mutual fund structure which is comprised of numerous investments/stocks. The fund manager will buy and sell those investments as he/she feels is required to meet the fund’s objective. Each time an investment within the fund is bought or sold, it can create a gain or loss (called a distribution) which is normally transferred down to each mutual fund unit holder (aka: you) throughout the time you hold the investment.
A corporate class is similar; however, the structure of the company that owns and manages the entire mutual fund is different. A standard mutual fund is set up as trust and considered to be a separate entity from all the other mutual funds that the parent company owns; therefore, must deal with taxes individually. Corporate class funds are not separate entities from one another therefore income and taxes are jointly managed as one single company. This results in a minimization of the gains/losses that you normally would be accountable for paying taxes on while you hold your mutual fund. This can be a significant tax benefit to unit holder.
Being smart about your taxes is always a good strategy. Corporate class funds are one way to help reduce your immediate tax bite outside of a registered plan while keeping more of what you make invested.