Many of you will know that some government benefits that you receive are income tested, meaning that if you earn more than a certain level of income, some or all of your benefits could be clawed back.
As you may well know any income withdrawn from an RRSP or a RRIF will be taxed as income and there is simply no way around that. But how can we draw tax-deferred income from our non-registered investments even though we might have made money on them.
Many mutual fund companies in Canada offer tax efficient withdrawal programs. These tax efficient withdrawal programs allow you to withdraw anything from one to eight per cent of your non-registered investments on a tax-deferred basis.
Let me explain, there are essentially two things that need to happen for you to be liable to pay tax on a non-registered investment.
The first is you need to make a gain and the second is that you need to dispose of your investment, both these need to be achieved to create a tax bill.
o how do these mutual fund companies pay you income on a tax deferred basis?
What these companies do is pay you return of capital (ROC). Return of capital simply put is your own money being paid back to you.
When you purchase one of these investments you have an adjusted cost base (ACB). As you withdraw income from this investment the mutual fund company simply reduces your ACB, they do not sell your mutual fund units therefore it is not treated as a disposition for tax purposes.
So if for example you were withdrawing eight per cent per year your ACB would take approximately 12 years to reach zero, and similarly if you were withdrawing six per cent per year your ACB would take approximately 16 years to reach zero. Once your ACB hits zero then all future income is taxed as a capital gain.
Where this strategy works particularly well is when you need extra income but would like to avoid the claw back of your government benefits or if you know that you will be in a much lower tax bracket later in life.
Generally speaking tax deferral strategies do make sense particularly because you can invest the unpaid tax making a return on it before it ultimately becomes payable.
Remember to always consult your advisor before taking any action.
Written by Stuart Kirk, CIM. Stuart Kirk is an Investment Funds Advisor with Manulife Securities Investment Services Inc and a Retirement Planning Specialist with Hicks Financial Inc. The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Investment Services Inc or Hicks Financial Inc. For comments or questions Stuart can be reached at stuart@ghicks.com or 250-954-0247. Manulife Securities Investment Services Inc. is a member MFDA IPC.
