Get the cash flow you need from mutual fund distributions

January 4, 2016

The type of and how mutual funds are taxed is an important consideration for investors.

Many investors today, particularly those in retirement, seek out mutual funds with income-producing features. But how do you know which product is right for you? Before investing in a mutual fund, it’s important to know what type of distribution you are going to be receiving as each investor has their own unique income needs and tax circumstances.

Not all mutual funds pay distributions and some pay them at different frequencies, i.e., monthly, quarterly or annually. Some funds have specific target distribution levels, usually an annual percentage. It is important for investors to check the fund’s prospectus to confirm the fund’s distribution policy.

The fund’s distributions will also be taxed depending on what they consist of: interest, dividends, capital gains, return of capital and/or foreign income.


Mutual funds that contain dividend-paying stocks can offer an attractive source of tax-preferred cash flow (dividends are treated more favourably than interest income from a tax perspective) and the potential for capital growth. However, for investors seeking cash flow necessary for living expenses, a fund distributing dividends may not always provide steady and predictable cash flow. Dividend payments are not guaranteed, and even if dividends are paid on schedule, the amount, itself, can change.

Interest income

Interest income, typically received from mutual funds that invest in Treasury Bills or corporate or government bonds, contributes to cash flow but is added to your income and taxed at your highest marginal tax rate. Consequently, it might be more beneficial to have these types of investments inside a registered account such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA), so that this income is tax-sheltered. Also, interest income might not be ideal for investors seeking a regular source of income, as today’s environment of low interest rates has generated relatively small payouts.

Capital gains

Capital gains result when you sell an investment for more than you purchased it. The difference is taxable at 50% of your marginal tax rate. Capital losses can also occur if your disposition (i.e., sale of mutual fund units) results in receiving less money than you had originally invested. Because of the favourable tax implications, capital gains are an efficient – but not guaranteed – source of cash flow, and can be ideal outside of a registered account.

Return of capital (RoC)

To create cash flow, a mutual fund may return a portion of the money that had originally been invested by unitholders (or shareholders) of the fund. This “return of capital” results in a distribution to investors that is not immediately taxable. Mutual funds that pay RoC to the investor on a regular basis can be ideal for investors looking for regular streams of cash with minimum immediate tax consequences, since they are drawing primarily or completely from their invested principal.

Generally conservative products, like asset allocation funds and balanced funds, usually pay regular distributions but can also help protect your investment by limiting losses during market downturns while still providing some growth potential – a crucial component when drawing income in retirement.

To learn more about finding a product tailored to your unique income needs, talk to your financial advisor or visit

The contents of this Web site are provided for informational and educational purposes, and are not intended to provide specific individual advice including, without limitation, investment, financial, legal, accounting or tax. Please consult with your own professional advisor on your particular circumstances.

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