Please be careful with T-SWP’s A Cautionary Tale to Check Your ACB

Has your advisor been suggesting that your next mutual fund be a T-SWP series? If so you better continue to read below before you say yes.

A recent rage in mutual fund promotion has been T-SWP’s. A SWP stands for Systematic Withdrawal Program. What this means is that those enrolled in a SWP will withdraw a certain percentage of their mutual fund value each year. The value generally ranges from 4% and up. The purpose of a SWP is to provide a cash flow to the holder of the mutual fund. For example, if you had $100,000 invested in SWP mutual funds that provided a 4% distribution out to you, you would receive $4,000. This $4,000 could be broken down over monthly instalments, quarterly instalments or a single payment.

Generally, SWP’s will give a portion of the gain to the client and in certain circumstances a portion of a return of capital. (In simplest terms, a return of capital is a return of your own money invested in the mutual fund). You will receive a T3 or T5 at the end of the year that will tell you how much of what you received from your SWP is taxable.

A T-SWP stands for Tax efficient Systematic Withdrawal Program. What this means to the client is that most, if not all, of the distributions that they receive from the systematic withdrawal program are a return of capital. In other words, the mutual company is giving back your own capital and letting any gain from the growth of the mutual fund accumulate within the mutual fund. Because a client is receiving a return of capital, which is their own money, they can not be taxed on it. Therefore, the SWP becomes tax efficient. A T-SWP is great for people that are looking for income that produces little or no immediate tax consequences.

One thing that everyone must come to terms with in Canada is that the tax man will always get his share in the end. You can delay and or put off the tax man, but eventually he gets paid. The same is true for T-SWP’s. Please don’t think that you are winning a game against the tax man when you are using a T-SWP. What you are really doing is delaying the inevitable. Here is the reason why.

When you participate in a mutual fund series that is a T-SWP, as we discussed above, you are getting a return of capital (your distributions are returning your own money). This means that you aren’t paying taxes on your own money being returned to you. However, because you are getting your own money back you are reducing the amount of money that you have invested in the mutual fund. Below is an example:

Let’s say that you invested $100,000 in year one and for argument sake your T-SWP has been really tax efficient and has only returned your money to you at 4% through a distribution at the end of each year. Now this scenario wouldn’t be complete unless we had a gain or loss involved. For simplicity sake, let’s say that your gain has been 5% every year.

Your original book value was $100,000; which bought you 10,000 units at $10/unit. At the end of each year you have received your tax efficient systematic withdrawal program of 4%. Because your mutual fund has grown throughout the year by 5% that 4% T-SWP will increase each year. But because you are taking a 4% distribution in the form of a T-SWP your mutual fund is growing, but not by 5%. Your visible gain in the first year is only $800 and not the $5,000 most would assume.

What really is happening is that since you are receiving a return of capital through a T-SWP that yearly T-SWP 4% is being taken off your original invested capital of $100,000. That is why the Adjusted Cost Base (ACB – see below for a simple term) is shrinking in value. While at the same time your visible investment is slowly growing. I call this your visible investment because in most cases your mutual fund company will only report this number to you in the form of Market Value. On first glance your investment is growing by the difference between a gain of 5% less a T-SWP of 4%. However, in reality your investment is growing by 5%. But since you are taking 4% away in the form of a T-SWP it is visibly only growing by a fraction of the 5%.

If your mutual fund was growing at 3% you would actual show a visible loss. This fact has heavily impacted End of Year Market Values for many investors who have taken any form of SWP during years when their mutual funds have performed at a percentage below the SWP. In 2008 a vast majority of mutual funds reported negative returns and this was compounded by SWP’s. For example, if you had a SWP of 8% and your mutual fund reported a loss of 10% in fact the visible impact on your mutual fund was -8%-10% or -18%. In actual fact the SWP of 8% for that year was a return of capital and therefore your Adjusted Cost Base will be reduced. This is a fact in any case where the SWP amount is greater than the performance of the mutual fund. This is a danger all people who take SWP’s must face. The simplest way I can explain this is that the amount you take in a SWP, whether it be 4% or 12%, it becomes your new bench mark for your mutual fund’s performance. If your mutual fund does not perform at the amount that you are taking from it the difference will be a return of capital. For example, using the 3% gain mentioned above and a SWP 4% there is a visible loss. As the distributions from the SWP’s must be paid out the difference between the gain and SWP will be paid out as a return of capital. If you are using a SWP the chances are you will get a t-slip that reports a portion of the gains even though you see a visible loss.

But since you are taking a T-SWP chances are you won’t be reporting that gain, but you will be subject to the effect of a gain less than the SWP being taken. As well, since you won’t be reporting the gain because you will be receiving a return of capital your Adjust Cost Base will drop by the amount of capital you are getting back. In the scenario above it is 4%. This makes sense because if the money you are getting back is your own money that you originally invested then it makes sense for the amount of your original capital being reported should go down as well.

There doesn’t seem anything wrong with this until you decide to sell your mutual fund. When you decide to sell your mutual fund you are taxed on the difference between the market value of your mutual fund at time of sale and what you invested in the mutual fund (ACB). In year ten of the scenario above that is $108,294 (market value) less $60,967.55 (ACB) = $47,326.45 taxable gain. It is not the $8,294 which appears to be your visible gain.

As I mentioned above, in Canada you can’t avoid the tax man. You can delay or put off the tax man for a period of time, but inevitably taxes need to be paid. Therefore, when you go to sell your mutual fund that you have been receiving T-SWP’s from you are going to have a taxable gain of $47,326.45 and not $8,294. This can be a shocker for some people who have not been explained this fact by their advisor. In some cases it could have quite a dramatic affect on future plans.

When dealing with T-SWP’s please make sure that you are well aware of the fact that if your mutual fund reports an overall gain between the time you bought it and the time that you sell it, you will be paying tax on those gains; which might not be anywhere close to the visible gains that you see being reported as your Market Value.



Adjusted Cost Base (ACB) – In simplest terms is the amount it cost you to buy an asset. This includes any additions (reinvestments, additional contributions) and subtractions (withdrawals). ACB = initial investment + reinvestments + additional contributions – any withdrawals

When do I invest in RSP’s?

When do I invest in RSP’s?

For many people RSP’s are something they think about only between January 1st and March 1st. Unfortunately, some people don’t even think of them at all.

Why? RSP’s should be built into your monthly schedule like paying your mortgage or paying for your car insurance. People just need to think about it in a different way than they currently do.

Let’s call it paying yourself Forward.
Everyone knows that having a car is a big, most often a necessary, expense. Cars chew up a sizeable amount of someone’s income. Paying for food is also another necessary expense; as is shelter. So let’s look at the average person’s necessary monthly expenses and let’s do it in a Maslow like hierarchy.

1. Food
2. Shelter
3. Heat and hydro
4. Clothing
5. Transportation
6. Cable and telephone
7. Entertainment
8. stuff

It’s important that a person has the resources to pay for the categories one to five. If you have kids they still need the same things; so you add them into the same categories. The quality and style to which a person pays for the first five in the hierarchy is a matter for living within your means or not. Unfortunately, a vast majority don’t…but that’s another article.

However, the sixth category should not be cable and telephone, but rather paying towards an RSP. The first five categories are necessities. They are what people in a modern society need in order to function. From six onwards they are what I call luxuries.

If you look at this list it only considers immediate categories. It does not take into account future categories. We live in a world where our past affects or present and our present affects our future. So why not prepare now for the future. Build in future categories into our present hierarchy of needs. For most we are already dealing with past categories in the form of bills.

The real goal for a lot of people is to not live for the moment and the past, but plan for the future. I know for some it is easier to have the gratification now and hope the future works out. What this tends to do is add past categories in the form of bills to present and future categories. This is poor planning and managing of your resources.

Let’s look at the above list again, but with past categories, present categories and future categories put in the order of how most peoples deal with them.

1. Food
2. Shelter
3. Past Bills
4. Stuff
5. Entertainment
6. Clothing
7. Hydro and Heat
8. Transportation
9. Cable and Telephone

The problem with this list is that it takes into account past categories and present categories. The past category of bills is rather high up on the list because most people are paying now for things they’ve done in the past.

This is an unfortunate way to go about life. People should be looking forward and to do that people need to put a little aside every month. It doesn’t have to be a lot. A little over time has an effect. The ideal list that people should be striving for is:

1. Food
2. Shelter
3. Saving for the future
4. Hydro and Heat
5. Transportation
6. Clothing
7. Cable and Telephone
8. Stuff

You noticed I didn’t put bills in this listing. The goal that everyone should have is keeping their bills to a minimum by paying them off every month and replacing paying past bills with saving for the future. This will help people from paying for things they did in the past to planning for the future. And isn’t that a better way. In other words, everyone should be saving a portion of their income every month and putting it towards their RSP’s.