Q. How do corporate class mutual funds work and how can I benefit?
A. Janis, the accounting details of a mutual fund corporation are long and dull. But in simple terms, a number of funds are pooled together within a corporation. This allows the taxable events of each fund to be traded off against one another before distributions are paid out to the investor.
There are two main benefits to this structure:
- The first benefit is potentially lower taxable distributions resulting in a tax deferral. This is why advisors will recommend them for personal and corporate investment accounts;
- The lower taxable distributions, of course, reduce your overall taxes which is important for retirees trying to avoid clawbacks, and maximize supplements and tax credits.
It’s as equally important for people accumulating wealth. The smaller the distribution, the less tax you pay, the more your cash flow increases, and the more money you have to invest. Many investors don’t know the after-tax return of their non-registered investments.
If you can find a regular fund that is managed tax efficiently, meets your investment criteria, and has distributions similar to the capital class fund you are considering, go with the regular fund.
The second benefit of capital class funds is that only capital gains and Canadian dividends flow through a mutual fund corporation.
This can give a non-registered bond fund a real advantage. No more interest income which is 100% taxable, just capital gains tax which is 50% taxable, making your after-tax return higher.
The third big benefit that was eliminated by the federal government in 2016 was the ability to switch tax-free between capital class funds.
Janice, here’s an article on the mechanics of corporate class funds from CI funds.
READ: ETFs or mutual funds?
Corporate class funds are useful in certain situations but be prepared for some distributions. You may have heard that capital class funds don’t pay out any distributions at all. They can and they do, and it is important to note that when doing your tax planning.
Allan Norman, M.Sc., CFP, CIM, Atlantis Financial/IPC Investment Corp
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