Brian and Krista met with me recently to determine what kind of income their investments could generate now that they were retiring. A recent inheritance boosted their investment total to around $2 million. They both had great pensions but were concerned about OAS claw-backs. Sound familiar?
When it comes to non-registered investing, tax efficiency is a big part of the retirement equation. Since Brian and Krista were ready to start reaping the benefits of their investment returns, I suggested we switch their existing portfolio in their non-registered account to a T-Class program for tax efficiency.
To better understand the tax-efficiency benefit, we should take a look at a historical comparison between T-Class (corporate class portfolio) and regular mutual funds (trust portfolio) using a balanced portfolio of 60% equity and 40% income.
Historical comparison*:
Product: Fidelity Global Balanced Portfolio
$1M invested in non-registered account, assuming a 5% monthly payout
Investment period January 2008 to April 2024 (16 years)
T-Class Portfolio | Existing Portfolio (Trust) |
Balance Jan 2008: $1,000,000 | Balance Jan 2008: $1,000,000 |
Balance April 2024: $1,258,210 | Balance April 2024: $1,170,536 |
16 yrs of cash flow: $832,984 | 16 yrs of cash flow: $801,759 |
Benefit to client after 16 years: $1,258,210 + $832, 984 = $2,091,194 | Benefit to client after 16 years: $1,170,536 + $801,759 = $1,972,295 |
Using the same portfolio that has the same performance and fees, the existing mutual fund portfolio paid 5X the amount of taxes on the distributions vs. the T-Class portfolio.
This resulted in the T-Class version providing $118,899 additional benefit to the client:
$2,091,194 - $1,972,295 = $118,899.
Tax-Efficient Income biggest T-Class benefit
1. It provides Brian and Krista with cash flow by returning their original investment principle in a return of capital (ROC) making the withdrawal non-taxable.
2. The T-Class program does not affect the OAS claw-back.
3. We’re allowing the investments to grow by deferring the taxes. Once the ROC is depleted, any cash flow down the road is treated as capital gains; however, it is taxed at a lower rate than other sources of income.
4. They can defer any capital gains, but still receive an income from their non-registered account in a tax-efficient manner.
5. Brian and Krista can choose to turn the cash flow off or reduce it according to their expenses – like in two years after they replace the roof of their house.
Saving $118,899 is like getting a free 10-day cruise every year for the next 15 years or so!
Lastly, any excess funds each year can be reinvested into more conservative funds as they age - a perfect solution for this retiring couple.
Do you think they switched? They did.
*In the hypothetical performance example for this portfolio, the returns of the Portfolio’s benchmark over the period from January 07, 2008 to April 30, 2024 are shown. You cannot invest directly in an index, and there are no fees associated with it. Average ROC is calculated since the Fund’s inception and includes re-invested distributions. Assumes a marginal tax rate of 53.50%. Mutual funds are not guaranteed and information on returns is based on past performance which may not reflect future performance. Mutual funds may be associated with commissions, trailer fees, management fees and other expenses. Please read the prospectus. Important information regarding mutual funds may be found in the simplified prospectus. The indicated rates of return are the historical annual compounded total returns, including changes in the unit value and reinvestment of all distributions and do not take into account entry fees, redemption, distribution or various charges or income taxes payable by any security holder that may have reduced returns. To obtain a copy, please contact me. Brian and Krista are fictional.
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