We did the poll and know from direct feed back that some people did not respond, while the numbers show that many contributed their experience. Thank you for your perspective! And what we found.

With trusts growing from launch to mid-2005 at a median annualized total rate of 38% of which 8% is the median rate of distribution, a majority of investors might be holding fast-growing capital gains in their registered retirement savings accounts.

Despite what the government says, we trust investors are adding—not artificially taking away—taxes to Canadian coffers.

Imagine unit price growth as a capital gain that works on a compounding basis. Canadians might have ballooning RRSP and RRIF accounts thanks to income trusts.

Distributions or Dividends: They Are Beneficial

In the Globe & Mail Saturday 24’th, Dereck DeCloet reminds us that Robert Arnott and colleagues published a study in the Journal of Financial Analysts in 2003 that proved that companies that pay dividends tend to perform better than companies that don’t.

DeCloet also notes that this premise holds true this year for Canadian companies: based on numbers from Bloomberg, the percentage of companies in the S&P/TSX composte index that have earned money for shareholders in the last year, is 86.3% among those that pay dividends, but only 59.6% among those that do not.

He’s written his article as a note to Mr. Goodale, as if the Minister of Finance cares about policy that sustains financial market values. Clearly the man has said things, however, to deflate investor confidence and asset values by telling people that the government expects to be paid taxes that it is owed.

DeCloet also missed noting that, according to our study, “Where’s the Good Money”, despite the fast growth in numbers of income trusts in our markets, there are still proportionately fewer equities that pay dividends of any kind in Canadian markets than in American markets.

When income trust returns are withdrawn from the retirement savings account, investors pay the maximum personal tax rate on the full amount.

In effect, your retirement involves saving fast-growing tax for Revenue Canada. Your account is like their tax capture account. You get the benefit of a one-time tax deduction when the money goes in.  Canada Revenue gets the benefit of growing capital gains and other returns that compound annually when the money is withdrawn by you, for you or your benefactors.

Simple Example

Assume your personal tax rate is 40%.  You had $10,000 to invest in 2000 when the income trust market was growing fast.  You earned 8% in distributions per year on those trusts and fully reinvested the money on a completely efficient basis, through a DRIP plan for example (assuming no benefit of a discount price on new units in the case of this DRIP).  Your trusts, like half the issues in the market, grow in price at an average annualized rate of 30%.  And now you either have to remove that $10,000 after five years or you need to in order to pay for your retirement.

The good news is that your $10,000 investment would be worth about five times as much when you need it, after five years.

Had you put the money into your RRSP, you would have saved about $4000 in taxes in 2000.  You wouldn’t be paying taxes on it or any investment gains until it is withdrawn from your registered account.  When you do withdraw it, you have a little more than $50,000 on which you’d pay about $16,000 in taxes.  Your total tax payments over the six year period would be roughly $20,000.

But you’re pleased that you have $30,000 in spending money. Great!

Now what if you held those income trusts outside of that RRSP?  You’d pay personal taxes on the income in year one.  You’d pay taxes on the distribution income over the following years.  For ease of calculation and results on the conservative end of the spectrum, we’ll assume that all of those distributions were fully taxable business or interest income: We falsely assume that none of those distributions involved traditional dividend income, return of capital or payments in respect of capital gains. When outside an RRSP or RRIF, you’d pay capital gains tax, at a reduced tax rate closer to 15%, when you sell the trusts to get the cash you need after five years.  Your total tax bill over the years would be almost $14,700.

Owning the trusts outside your RRSP in this case would give you an extra $1325 to spend when you need it.

Of course, if you invested in trust issues that came from the bottom half of the returns range, then the amount would be lower as would your returns.  The more trading you did, the more you’d pay in transaction costs.  And if you had a managed account of some kind, then you would most likely wipe out your savings in order to pay your advisor or manager to watch your investments win (for them).

But if you held trusts from the top half of the returns range, then the amount would be even higher.  The amount would also be higher if you kept your trading to a minimum and directed your own investments.  You’ve have more money still if a portion of the distributions received each year was treated as return of capital or dividends.  And all else being equal, the longer the holding at such a rate of return then the higher the returns and the greater the taxes “saved”.

So in our simple example, the government will have captured an extra $1325 in taxes if you decided to go their well-promoted savings route and used an RRSP to “defer” taxes.  What they don’t tell you is that you may be delaying your tax bill, but you’re also handing over a bigger portion of your gains by having fast-gaining investments inside your RRSP or RRIF.

Given the low interest rates at the moment, the time value of money is not enough to justify deferring taxes and paying this much extra cash to the government in terms of securities that grow in price.

Maybe this is why there is—all in good conscience—secondary government promotion of the suggestion that people put their most conservative investments into their retirement savings account.  The more interest you earn at a low rate inside the registered retirement account, the less the tax bill you will earn for the government.

Conclusion

A good financial planner who takes a holistic approach to savings, investments and tax planning can determine the best placement of investments to minimize tax liability.

The point of this poll was to get a general sense of the personal tax liability we create as Canadians who hold income trusts. If we put the specific numbers from the poll together with specific tax information from our comprehensive iTrustIndex, then we should be able to develop a more accurate picture of the tax winfall the government can expect from an aging population.

As the book “Boom, Bust and Echo” shows, Canada has a big aging population.  That echo in your ears might be the sound of the Canada Revenue Agency celebrating their boom in tax income while you feel busted upon cashing in and withdrawing your well-chosen income trust investments from that registered savings account of yours. Or should we say...account of their’s?

If our mini-poll reflects the Canadian investors’ experience at all, it suggests that Canadian income trusts, like dividend-paying equities, are often held inside RRSP and RRIF accounts to the net benefit of the Canada Revenue Agency and the tax coffers of Finance Minisiter Ralph Goodale.

Income trusts don’t owe the Department of Finance anything.  It appears to be the other way around.

How long is it before seniors have to make their increasing mandatory withdrawals and pay those growing tax bills deferred in Registered Retirement Savings accounts and Income Funds?

Good investing!  May your income be trustworthy. And happy retirement.<div class="vig_right"></div> <div class="vig_right"></div>