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Segregated & Mutual Fund

What's The Difference Between a Segregated Fund and a Mutual Fund?

Do you like the feeling of knowing that your money is well invested and well protected? Segregated funds combine the growth potential of a mutual fund with the security of a principal guarantee.

Guarantees:

Principal guarantee: Segregated funds operate under a fixed contract term, with a principal guarantee that protects your investments at maturity or death.

Maturity guarantee: When a deposit matures and is redeemed (generally a minimum of 10 years from the date of deposit), you will receive a top-up payment, less any withdrawals and fees, if the market value is less than the guaranteed amount.

Death benefit guarantee: When a segregated fund annuitant dies and the market value of the investment has declined, the named beneficiary will receive the guaranteed amount, less any withdrawals and fees. 

Ownership Structure:

Segregated Funds are a deferred annuity contract between an insurance company and a policy owner. The policy owner makes deposits through the contract and the insurance company invests the money in Segregated Funds. Segregated Funds are an asset of the insurance company and are similar, in essence, to money held in trust for the investor. The segregated nature protects the investor against the insolvency of the insurance company.

Mutual Funds are owned by the investor and are managed by the investment management company. The securities in the funds (owned by the investor's pooled resources) are maintained in safekeeping by the custodian of the fund.

Regulation:

Segregated funds are regulated by Life Insurance Act

Mutual funds are regulated by Securities Legislation


Succession Planning and Probate – Huge Differences

Mutual Funds:

Will be a part of the deceased's estate and distributed according to the will after the will is probated (fees)

Segregated Funds:

Segregated Funds are insurance contracts and a beneficiary can be named to receive any proceeds upon the death of the life insured which leads to the following benefits:

  • Can bypass the estate (and probate) through a named beneficiary designation.
  • Privacy preserved
  • The fund will not form part of the value of the estate (no probate fees or other fees like accountants, executors and lawyer fees )
  • Money liquidated and received by beneficiary typically much quicker
  • Not subject to the settlement of the estate
  • Not typically subject to the estate creditors' claims if the named beneficiary is a member of the family like spouse, parent, child or grandchild.

Creditor Protection

Because it is an insurance product, it offers creditor protection from policyholder's creditors while policyholder is alive but if it can be shown to have been purchased to avoid potential known creditor actions, it could be challenged.

Taxation

A segregated fund is considered a trust for tax purposes. This is important for two reasons:

  • The segregated fund will allocate all taxable income and realized capital gains to investors. This avoids having income taxed inside the fund at the top marginal rate.
  • The fund acts as a conduit, that is income and capital gains retain their characteristics as they flow through to the investor and appear on the T3 in the same way they were realized in the fund. In other words, dividends will be reported as dividends, interest as interest and so on.

There are two taxable events arising from investing in funds – Mutual Funds or Segregated Funds

  • Income allocation (controlled by company)
  • Disposition (controlled by investor) 

Capital Loss

Another segregated Fund advantage since Mutual Funds cannot distribute negative capital gains distributions. Capital losses are carried forward to be used against future gains within the fund.

Segregated Funds have the ability to flow through capital losses (138.1(3) of the Income Tax Act) to the individual investor (which can in turn be used to offset other capital gains realized in the same year)

In a year, for example, where there are both capital gains and losses to report, gains will be reported in the capital gains box (Box 21-- same as a mutual fund) and losses will be reported in the "Insurance Segregated Fund Capital Losses" (Box 37 -- only available to Segregated Funds).

With Segregated Funds, the investor gets to choose when to claim the capital losses as capital losses not used in the current year can be carried back three years or carried forward to future years. This is not the case with Mutual Fund investments. 








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