Canadian ETF Distributions
December is a time fund investors typically loathe - particularly in a year like this. Not only have stock markets been pummelled by a weak economy, dirty CEOs and accounting irregularities; but many investment funds, including ETFs, will hand investors a tax bill before the end of this month. I'm sure some would rather have a lump of coal. However, here is a summary of expected distributions and some advice on who should try to avoid them.
Both Barclays and TD Asset Management will pay the above-noted distributions on December 31, 2002 to unitholders of record on December 27. Given that it takes three business days for trades to settle, investors wanting to avoid these ETF distributions will want to submit their sell orders no later than Monday, December 23, 2002.
Distributions on iUnits can be seen here
Distributions on TD ETFs can be found here
For many investors, the most sensible course of action will be to just sit tight, and take the distributions. Investors should only consider taking action if the cost of selling is less than the tax avoided by skirting the distribution. Costs of selling come in two forms - direct and indirect.
Direct costs are more obvious: realized gains, brokerage fees and other costs. Indirect costs refer to opportunity costs. That's the cost of sitting out of a fund for any length of time - potentially missing out on any rise in price while on the sidelines.
Investors sitting on paper gains that are smaller than the expected distribution can simply sell out of the fund prior to the payout; then immediately buy back in after the distribution has been paid. You're out of a fund for the better part of a week but avoid the distribution.
Consider the case of the iG5 fund. Its share price has risen about 4% this year (to Dec. 16), and the expected distribution amounts to 5.5% of recent prices. On the surface, this seems like a nominal difference given the brokerage costs involved in avoiding the planned payout. However, more than half of the distribution will be fully taxable income.
(Capital gains are taxed at half of the rate applied to interest, and other forms of regular income.)
Taking the tax effect into account, investors sitting on a paper gain of much more than 8% on the iG5 may want to consider selling to avoid the 5.5% distribution. Investors must also pay careful attention to the round trip brokerage costs involved in selling and buying back. If you have much more than $4,000 invested in the iG5 units, it may well be worth the trouble.
For those in a loss position looking to avoid a distribution, more care must be taken to avoid superficial losses to ensure investors are able to use the losses in the year realized.
There is a 61-day period of which to be aware - 30 days before the sale date and 30 days after the sale date. During that period, neither the investor, the investor's spouse, nor a corporation controlled by either:
While you also can't buy what tax laws consider identical property, there are ways to avoid distributions while maintaining portfolio exposure. Switching to other similar funds can achieve the twofold objective of avoiding the tax hit resulting from a distribution and maintaining desired portfolio exposure during the 30-day post-sale period.
Again sticking with the iG5 example, investors may simply switch into a low fee bond fund (most are expecting little to no distributions - but check to be sure) to maintain exposure, minimize brokerage costs, and make a tax-friendly move.
Since most funds impose a short term trading fee if held less than 90 or 180 days, investors must also assess whether additional hassle and expense ratio costs are sufficiently less than the tax being avoided.
To revisit why realizing capital losses now, rather than later is important, revisit this previous article under the subheading of Capital Loss Planning.
Wishing you and yours a safe and happy holiday season!
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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