Many Canadians have invested in income trusts in recent years. There were just 70 income trusts and similar products listed on the Toronto Stock Exchange (TSX) in 2000. By 2006, that number had more than tripled.
There are many different kinds of income trusts. The type of trust depends on the type of businesses it invests in.
Four common types of income trusts
1. Royalty/energy income trusts
Royalty trusts have been around for years. They mostly invest in oil or gas properties, or some other natural resource. Sometimes resource prices go up and the company makes more money, so the trust may pay its investors a lot of income. The trust's unit price may go up as well, so investors can make money if they sell their units. If the price of oil or gas drops, however, distributions may be reduced and units can drop in value.
Also, oil and gas wells will run out in time. Unless the trust invests in new properties, it will have to wind down and investors may be left with units having little or no remaining value.
2. Real estate investment trusts (REITs)
REITs invest in income-producing properties such as shopping centres, office buildings, and apartment buildings. Some focus on just one type of property, while others diversify by investing in different types of properties. Small investors would not likely be able to invest in these properties on their own.
3. Utility trusts
These trusts invest in power, pipeline, and telecommunications companies. They tend to provide more stable distributions than royalty/energy trusts. That's because prices in these sectors do not tend to go up and down as quickly as oil and gas prices.
4. Business investment trusts
Instead of selling shares, companies looking for funds from investors may sell units in a business investment trust. There are now income trusts that create income from sales of everything from restaurants, pet food and yellow pages, to coffee, tea, and jam. These trusts are not like other investment trusts since they don't hold a pool of investments to spread out their risk. Businesses with strong and steady cash flows are better suited to being set up as business investment trusts.
Another option: Income trust funds
Some mutual funds invest in income trusts. Some people call them income funds, but the correct name is income trust funds.
Your costs may be higher because you pay for the fund manager's skill in choosing the income trusts and managing the fund. The fund also passes on the costs of buying the underlying income trusts. The main benefit is that you diversify because you are investing in many income trusts instead of just one.
Important news: On October 31, 2006, the Department of Finance announced changes to the tax rules for income trusts that are now law. Income trusts are now taxed the same as Canadian corporations. The goal: to remove the tax advantages that trusts had over corporations in the past.
The changes will apply to new income trusts that start up after October 31, 2006. For income trusts formed before that date, the changes will apply in the 2011 tax year. The one big exception: certain Real Estate Investment Trusts (REITs).
Remember: Income trusts have certain drawbacks
The tax rule changes may reduce the amount of income that investors get. Also, many investors don?t know that a trust can stop paying distributions at any time. So if you're going to buy an income trust, do your homework. You may also want to consult a professional adviser to help you choose the right investment.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.