One has to wonder just exactly what is a good investment strategy to achieve high after-tax investment income? While most of us are familiar with capital gains, dividends and interest income (as well as their tax implications), there are more and more investors turning to investments that pay “Return of Capital” distributions. This can help to reduce current tax burdens.
What is Return of Capital?
Distributions from a mutual fund may contain capital gains, Canadian dividends, interest income, foreign income and Return of Capital. A “Return of Capital” is any distribution from a mutual fund that is not treated as either capital gains, dividends or interest income. When you receive Return of Capital you are essentially getting back some of your original investment. When a fund’s value is increasing, the Return of Capital is in effect a “Return of Growth”. On the other hand, in declining markets, the Return of Capital is reducing the amount of the original investment. Return of Capital distributions are taxed as capital gains only when units of the fund are sold. This is because the tax cost of the investment is reduced by the Return of Capital distributed. Tax deferral is an important part of many tax planning strategies!
How Does This Benefit You?
Return of Capital distributions are an effective way to defer taxation of investment income. Tax-Deferral has several advantages:
• More cash available today
• Higher after-tax returns on investment income due to current tax relief
• Potentially lower your tax bracket since “Return of Capital” is not currently taxed as income
• The ability to pay the deferred tax with cheaper dollars in the future due to inflation
• More control over when to trigger your capital gains tax liability
• If tax rates are lowered in the future, your tax liability could be reduced.
Cash Distribution Funds provide investors with a monthly distribution, a portion of which will generally include a Return of Capital. By investing in these Funds, you can receive tax-efficient cash flow monthly. Please note that the distribution is not guaranteed and may fluctuate.