Investing

Income Fund vs Growth Fund Tax Implications?

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[OP]
Member
Feb 18, 2013
240 posts
45 upvotes
Scarborough

Income Fund vs Growth Fund Tax Implications?

Hello,

My Uncle/Aunt (both retired) have downsized to condo in Toronto and now have ~$400,000 in the bank

They both combined have ~$130,000 in TFSA room, and will be investing this amount in 50/50 equity/bond growth fund (with a Big Five Bank) but in which the equities and bonds are evenly split Canada/US/International (so well diversified)

They're debating about what to do with the rest of the money.

They both have said they do not require the additional funds ($270,000) to produce regular income (they have no mortgage, and recurring bills covered through OAS/CPP etc)

They have been advised (by the same Big Five Bank) to invest the remaining amount in a monthly paying income dividend fund which is evenly split between equities/bonds, but is heavily weighted towards Canadian funds (90% of holdings are Canadian) Then, they were advised that the dividends would be re-invested into the TFSA accounts when additional room becomes available. They said this makes sense from a tax perspective...

My question is wouldn't it make more sense to simply invest the $270,000 in the same well diversified fund (but in non-registered account obviously) as the $130,000?

My Aunt/Uncle only wish to be able to make at most 2-3 withdrawals from their funds per year in case they want to take a trip etc...

Thanks for the help!
6 replies
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May 11, 2014
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The tax implications will depend on the exact fund you have, but in general, dividend and capital gains are taxed advantageously over income funds. That being said, with your aunt/uncle in retirement, fixed income is inevitable with their need for less risk. The banker is probably focusing on Canadian equities vs foreign in the non-registered as dividend income is eligible for Dividend Tax Credits for Canadian sources.

Could you state the fund(s) that the bank has suggested? Based on what you have stated, I am guessing it is TD and the TD Comfort Balanced Portfolio that TD has suggested.
https://www.td.com/ca/en/asset-manageme ... undId=6321

So as for the strategy they have set up can work, however, based on the fact that they have excess funds ($270,000) being non-registered and $130000 in a TFSA, I would suggest to them to slightly change tack.

First, I would have them set aside funds that would be needed in the next 5 years for trips. misc. etc. on the side. This allows them to access these funds without having to cash out the investment. For example, have them purchase a $10000 1,2,3,4 and 5 years GIC from the $270000 or have that $50000 put in a high interest savings account that is for spending. Any income produced from the non-registered plans could be deposited into this account for trips. Of course the amount should be narrowed down as this will really depend on your aunt and uncle's needs. If their 2-3 times a year can be lower say $6000 per year, adjust accordingly with some leeway.

Based on your statement that they do not need the $270000 to make income, does that mean the $130000 is required to produce income for them to live? If so, I would suggest doing the opposite. I would allocate about $180000 in the non-registered funds for the purposes of producing income, and then focusing on more growth on the TFSA. The reason for this is that by focusing on growth on the TFSA and allowing it to grow, this gives your aunt and uncle increased tax-free room overtime.

Assuming 5% growth on the investments (both TFSA and non-registered), 2.5% of that being income on the non-registered funds and a withdraw rate of $10000, with $12000 contribution room increase per year, a plan can be made like this....
-------------------Non-Reg-------------TFSA----------
start $270000 $130000

year 1 income on Non-Reg =$6750, withdraw $3250 from non-registered, transfer $12000 from non-registered to TFSA
-------------------Non-Reg-------------TFSA----------
endyr1 $261500 $148500

year 2 income on Non-Reg=$6537.50, withdraw $3462.50 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr2 $252575 $167925

year 3 income on Non-Reg=$6314.38, withdraw $3685.62 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr3 $243203.76 $188321.25

year 4 income on Non-Reg=$6080.09, withdraw $3919.91 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr4 $233363.94 $209737.31

year 5 income on Non-Reg=$5834.10, withdraw $4165.90 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr5 $223032.14 $232224.18

year 6 income on Non-Reg=$5575.80, withdraw $4424.20 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr6 $212183.74 $255835.39

year 7 income on Non-Reg=$5304.59, withdraw $4695.41 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr7 $200792.92 $280627.16

year 8 income on Non-Reg=$5019.82, withdraw $4980.18 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr8 $188832.56 $306658.52

year 9 income on Non-Reg=$4720.81, withdraw $5279.19 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr9 $165274.18 $333991.45

year 10 income on Non-Reg=$4131.85, withdraw $5868.15 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr10 $151537.88 $362691.02

year 11 income on Non-reg=$3788.45, withdraw $6211.55 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr11 $133326.33 $392825.57

year 12 income on Non-reg=$3333.16, withdraw $6555.84 from non-registered, transfer $12000 to TFSA
-------------------Non-Reg-------------TFSA----------
endyr12 $118103.65 $424466.86

I'm gonna stop here as this is just an illustration. Also keep in mind I haven't considered any taxation implications on the investment income. 5% growth with 2.5% income on the non-registered could also be too optimistic. If the TFSA funds are for longer term, your aunt and uncle are in good health, they could consider increasing the equity weighting in the TFSA to focus on growth. At year 12, the TFSA balance is around $400000 which at 2% would provide $8000 in tax-free income.

I think the plan of what funds the bank suggested are fine. The Canadian focus on non-registered makes sense. If your aunt/uncle or you are comfortable, setting up your own investment funds could help to reduce costs but this does come with the need to select your own funds and keeping prudent. Also ensure portions of the funds are liquid by substituting GICs/HISAs account within the funds.
The Non-Registered fund could look like a higher equity fund with GICs replacing what the bonds would make up. By structuring the fund this way, you keep the equity portion fully invested without the need to sell it and the GICs/HISAs make liquidity much easier.

If you could provide the exact funds the bank provided, the general costs for your aunt and uncle for both monthly and trip costs, this will make it easier to build a more accurate illustration. We could also look at other options from the bank or outside should that interest your aunt and uncle.
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[OP]
Member
Feb 18, 2013
240 posts
45 upvotes
Scarborough
Hi, thanks for the very detailed reply! Much appreciated

The exact income fund recommended for the $270,000 is from CIBC, found here: https://www.cibc.com/en/personal-bankin ... folio.html

And to answer your question, no, they are not relying on any of the investment returns to produce income, they have all of their expenses covered through OAS/CPP.

They can definitely keep their general/trip costs below $6000 per year.
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caddie444 wrote: Hi, thanks for the very detailed reply! Much appreciated

The exact income fund recommended for the $270,000 is from CIBC, found here: https://www.cibc.com/en/personal-bankin ... folio.html

And to answer your question, no, they are not relying on any of the investment returns to produce income, they have all of their expenses covered through OAS/CPP.

They can definitely keep their general/trip costs below $6000 per year.
If that is the case, they can definitely look at looking at increasing their spending.

Also, I am assuming they are fairly frugal? Keep in mind to have them change their bank account to the Smart Plus Account so they get everything unlimited and they can get one of the premium credit cards for annual fee free with $100k investments. They could get one of the travel cards to help reduce their travel costs further.

With the fund the selected, I am not the biggest fan and the growth prospects that I gave will not be achieved and the above illustration will not happen. This fund is also poorly rated in it's class. I will take a look through CIBC. But more importantly, how comfortable would you/your aunt& uncle be with using a online brokerage instead? This would change some aspects in their investment options.
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Jr. Member
Aug 29, 2018
131 posts
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Toronto
As an independent advisor, I can’t help but be agitated when I hear about the recommendations bank advisors are making to unknowing customers. I can’t say I’m surprised at all that they would “recommend” one of their cookie cutter “income” portfolios for your uncle and aunts funds. More unethically, the 2.22% MER, for which the “house” will undoubtably collect an annual 1% trailer for likely no ongoing or even decent advice makes my head explode.

On a $400,000 portfolio your family members will be paying $8,800 year in management fees - and for subpar performance at that. About half of this fee is for “advice”. Will they be receiving $4,400 of value per year? It’s very unlikely at any branch level. I understand the trust folks have in the banks, but if ppl really knew the cost of that trust, perhaps they would rethink the true intention here.

With $400k of investable assets, your aunt and uncle have many options outside of the major banks. All in they shouldn’t be paying more than 1.5% - and that includes ongoing and comprehensive portfolio management and financial planning.

Lastly and a BIG FYI - given the vast majority of their funds are non-registered, by the bank putting their funds in an A series imbedded fee product like the CIBC managed product, their advisory fees are not deductible on their tax returns. If instead they used a fee based advisor, even at 1%, they are looking at close to $3k year in tax deductions. It’s a no brainer in my opinion.

Good luck!
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ParadigmWM wrote: As an independent advisor, I can’t help but be agitated when I hear about the recommendations bank advisors are making to unknowing customers. I can’t say I’m surprised at all that they would “recommend” one of their cookie cutter “income” portfolios for your uncle and aunts funds. More unethically, the 2.22% MER, for which the “house” will undoubtably collect an annual 1% trailer for likely no ongoing or even decent advice makes my head explode.

On a $400,000 portfolio your family members will be paying $8,800 year in management fees - and for subpar performance at that. About half of this fee is for “advice”. Will they be receiving $4,400 of value per year? It’s very unlikely at any branch level. I understand the trust folks have in the banks, but if ppl really knew the cost of that trust, perhaps they would rethink the true intention here.

With $400k of investable assets, your aunt and uncle have many options outside of the major banks. All in they shouldn’t be paying more than 1.5% - and that includes ongoing and comprehensive portfolio management and financial planning.

Lastly and a BIG FYI - given the vast majority of their funds are non-registered, by the bank putting their funds in an A series imbedded fee product like the CIBC managed product, their advisory fees are not deductible on their tax returns. If instead they used a fee based advisor, even at 1%, they are looking at close to $3k year in tax deductions. It’s a no brainer in my opinion.

Good luck!
Agreed. CIBC also buries all their information deeply which makes it very difficult to figure out anything about their funds. I looked up the CIBC Managed Monthly Income Fund and couldn't even find distribution and yield information easily on the CIBC website. Morningstar ended up being a better resource.10 year annualized portfolio return of 4.4% is abysmal on a 55% equity and 45% fixed income portfolio. Fundata and Morningstar place it on the bottom quartiles of return in it's fund class.
https://www.morningstar.ca/ca/report/fu ... lang=en-CA


I'm hoping OP's aunt and uncle would be comfortable going elsewhere or using CIBC Investor's Edge and go self-directed. I can suggest a portfolio made of ETFs to recreate a monthly distribution fund, but it's a bit harder with mutual funds if they want to try simplicity.
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OP

Even though you hadn't answered the question about whether you/aunt&uncle would possibly do self-directed, I decided to construct an ETF portfolio similar in structure to that CIBC fund. This portfolio contains ETFs. Keep in mind that this would also accrue a $6.95 commission at CIBC Investor's Edge to buy each of the ETFs (there are 3). However, long term, and the fees involved means possibly saving a few thousand dollars each year for your aunt and uncle.

Here is what I put together

45% CDZ iShares S&P/TSX 60 Canadian Dividend Aristrocrats Index (MER: 0.66%, Yield: 4.00%)
10% CYH iShares Global Monthly Dividend Index (MER:0.66%, Yield 4.37%)
30% VAB Vanguard Aggregate Bond Index (MER: 0.09%, Yield 2.66%)
15% High Interest Savings Account B2B Bank 3.3%, Motive Financial 2.8%, Alternabank 2.25% etc.

This portfolio has an effective MER of 0.39%, plus $19.95 in total commissions to get started ($6.95*3). The effective yield is 3.37% if using Alternabank, and 3.53% if using B2B Bank. The CIBC fund currently yield 3.84% according to Morningstar, so keep in mind the yield returned is a touch lower. That being said there are a few benefits.

On $270000, the management cost savings is substantial. This is approximately $4900 in management fee savings per year. Additionally because 15% of the portfolio is in a HISA, it makes it much easier to transfer these funds out for travel and deposits into the TFSA. $40500 (15% of $270000) is $900~$1350 in interest a year and withdraws are generally fee free meaning your aunt and uncle do not have to sell funds immediately. The remaining investment funds $229500 will earn approximately $8100 in dividend and interest income. During the first few years in the brokerage account, this cash can be withdrawn to the high interest savings account, or if not needed, used to buy more units of ETFs as seen fit.

As a comparison of growth comparison, the CIBC fund over 10 years grew approximately 4.4% per year. This portfolio I created? 10 year return 6.13% and this is conservative as I used 2% for the savings account which is lower than what you can get.
(I used XBB return in 10 years to replicate VAB as VAB does not have 10 years of history). Ironically, the difference in performance is approximately the difference in fees which goes to show the effect fees have. 6.13%-4.4%= 1.73%. MER difference 2.22%-0.39%=1.83%. If I used a higher interest rate for the savings account, they'd be pretty much the same.If CIBC's fund return was a bit higher, one could argue their management was a bit better, but if the difference in performance equates the fee, then superior management can be ruled out.

There are other brokerages that may be cheaper than CIBC IE, but doing this will allow your aunt and uncle to keep their banking intact, take advantage of CIBC Smart Plus as well as the fact that CIBC IE isn't too bad fee wise.

So there is disadvantages. This does involve work to do on your own. However the cost savings and much better returns here. I wanted to just demonstrate your other options. You may very well want to continue using the bank, but this may want you guys to think over all your options first.

Could you also state the fund the banker recommended for the TFSA?
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