Using Series T for income now and charitable donations later

Many Canadians may be looking for ways to increase the tax efficiency of their retirement investments. Additionally, they may want to give to charity while taking advantage of the tax benefits of donating investment funds.

Did you know that there’s an investment option that can combine both of these objectives? An investment in a Series T fund can give you tax-efficient income now and a tax-effective way to donate in the future.

If the ability to receive more after-tax income today and eliminate capital gains tax on future donations seems appealing, this strategy could be for you.

What’s a Series T fund?

For non-registered investments, a Series T fund (also known as T-Class) can provide a regular stream of tax-efficient cash flow from monthly distributions. All or a significant portion of the distribution received is likely to be considered tax-free return of capital (ROC). This essentially defers the triggering of capital gains from monthly withdrawals.

Each time the fund distributes ROC, the adjusted cost base (ACB) of the investment decreases. Since ROC is considered after-tax money, there’s no tax payable on this cash flow. However, there may still be taxable distributions similar to those of a mutual fund.

Once the ACB reaches zero, additional ROC distributions are taxable as capital gains. Since capital gains are only subject to a 50% inclusion rate, the cash flow would still be considered tax efficient.

The opportunity

Through the power of ROC distributions, Series T funds can provide tax-efficient income. The ROC distributions from a Series T fund can also help lower the taxable income reported each year and reduce the clawback of income-tested government benefits, such as Old Age Security (OAS) and the age amount tax credit.

In addition, normally when transferring the ownership of publicly traded securities like stocks, bonds, mutual funds, and segregated fund contracts to charity, the donor would have to pay tax on 50% of the capital gains realized from the assets’ appreciation in value. However, under a special government incentive program, the donation of publicly traded securities benefits from a capital gains inclusion rate that’s reduced to 0%. In other words, the tax on any capital gains from the disposition of publicly traded securities donated directly to a charity has been eliminated—a significant tax savings.¹

Using these charitable gifting rules in conjunction with a Series T fund can help you generate tax-efficient income and eliminate the capital gains tax on the donation. By transferring ownership of some or all of these mutual funds to charity, you can take advantage of the zero-per-cent inclusion rate, eliminating the capital gains tax and receiving tax savings from the donation. This allows the tax that would‘ve been paid to the Canada Revenue Agency (CRA) to be redirected to a charity.

An example of how it works

Stephen, age 53, recently retired from his management position in a high-tech manufacturing company. He wants to start drawing a sustainable and tax-efficient income from $200,000 of his savings. His goal is for the $200,000 to remain constant or even grow at a modest rate so that someday he still will have an amount left to donate to charity.

Stephen invests $200,000 in a Series T fund that generates 6% in annual cash flow. This would provide him with an average after-tax income of $11,400 for 19 years.² The total he’ll receive over that period is $216,600, after tax. At that point, his ACB will reach zero.

Assuming a 6% annual rate of return, the market value of Stephen’s account will still be $200,000. If he cashes out the investment, he’ll have to pay tax on the full $200,000 capital gain he has realized—generating additional tax of $40,000.

At this point Stephen has several options:

• Maintain his investment and stop receiving ROC distributions altogether.
• Continue with future ROC distributions that will be less tax efficient.
• Donate the funds to charity.

Stephen chooses to make a charitable donation and transfer ownership of $67,000 of the portfolio to a registered charity. The capital gain realized on the transfer won’t be taxed and he’ll receive a $67,000 charitable donation receipt, which provides a tax credit equal to about $26,800 (depending on the province).

Stephen can now remove the remaining $133,000 from the Series T fund and the tax of $26,600 on the capital gain will be offset by his donation receipt.

This strategy has allowed Stephen to receive tax-efficient income from annual withdrawals and make a sizable donation to charity without triggering any tax on capital gains. Rather than paying this tax to the CRA, Stephen has redirected the funds to a charity of his choice.

Ideal candidates

• Individuals interested in tax-efficient cash flows from their investments
• Individuals planning to donate to charity and give back to their community
• Individuals looking for more flexibility in how and when they donate

Take action

Use a tax-efficient structure, such as Series T funds, to reduce taxes today and generate tax savings by donating part of the investment directly to a charity.

Did you know?

Corporations that own Series T funds can also take advantage of the 0% inclusion rate. However, while individuals receive a tax credit for the donation, the corporation would deduct the amount instead. In addition, since none of the gain is being taxed, the full amount of the donated Series T funds is added to the capital dividend account and can be distributed to shareholders tax free. See “Corporate class mutual funds: corporate donations” for more information.

1 This applies to direct donations to a charity (or donations in kind) while alive. If a direct donation occurs at death, a zero capital gains inclusion rate will only apply if the donation qualifies as a gift from a graduated rate estate (GRE). See section 118.1 of the Income Tax Act or “Charitable Giving - The facts” for more information on GREs and donations at death. 2 Assumes 6% annual rate of return. Stephen’s marginal tax rate is 40%, and taxable distributions of $1,500 per year and ROC distributions of $10,500 per year. For illustration purposes only.