The Canada Revenue Agency (CRA) ruled this week to force mutual fund dealers, advisors and fund managers to charge GST/HST on mutual fund trailing commissions starting Jan. 1, 2028.
While it’s an administrative headache for mutual fund vendors, it adds insult to injury for the overwhelming majority of Canadians who save for retirement through mutual funds in their registered retirement savings plans (RRSP), tax free savings accounts (TFSA) and non-registered investment accounts.
The insult is the tax. The injury is the hidden fee going to advisors each year that most investors probably don’t even know they pay.
What are trailing commissions?
Trailing commissions, or trailer fees, are intended to compensate advisors who recommend mutual funds and provide “ongoing advice”.
They are hidden because the fee is baked into the price. Trailing commissions are collected by mutual fund companies through a broader annual fee called the management expense ratio (MER).
Fund holders pay the MER based on the amount they have invested in the fund whether it makes money or not. MERs vary from company to company and according to asset class, but fees on equity funds often top 2.5 per cent.
Inside that fee a typical trailing commission is one per cent, but they also vary among vendors to make their funds more appealing to advisors who select them for their clients.
While one per cent might seem like a small amount it adds up to $5,000 each year on a $500,000 portfolio of mutual funds under investment. Add Ontario’s 13 per cent GST/HST, for example, and it’s another $650.
Not having that $5,650 invested and compounding over time can potentially take tens of thousands of dollars out a client’s retirement savings.
The trouble with trailing commissions
Mutual fund trailing commissions are banned in countries including the United Kingdom and Australia.
In addition to being hidden, the concept of having a mutual fund company reward advisors for choosing their mutual funds for a client raises questions about who the advisor is actually serving. Is the advisor recommending a fund each year because it is right for the investor, or because it has the highest compensation from the mutual fund company?
In some cases a lower cost exchange traded fund (ETF) or investing directly in the market would be far less costly, but many advisors are only licensed to sell mutual funds.
In reality, investors with modest portfolios who want diversification and professional management have no alternative.
The door is open to more hidden costs
“I think it’s fair to assume investors will bear at least some of the cost, and potentially a meaningful portion of it,” says David O’Leary. He’s the founder of Kindwealth, an advice-only firm that provides financial oversight for “Ultra High Net Worth” families – the sort of folks that never pay trailer fees.
He says if fund companies, dealers or advisors don’t want to absorb the additional costs (which they won’t), they will pass them along to investors.
Adding to the uncertainty, O’Leary says investors might have to pay GST/HST on new costs introduced into the mutual fund fee chain.
“It may shift over time and it probably won’t show up in a clean, obvious way,” he says.