A segregated fund is an investment fund that receives the pooled funds of investors who bought individual variable insurance contracts (IVICs) from the sponsoring insurance company. The contract owner makes deposits through the IVIC and the insurance company then invests the deposited money into segregated funds. These funds are segregated from the other assets of the insurance company, and are usually held in trust by a mutual fund company.

The insurance company owns the segregated fund assets but keeps them segregated from their other assets, to ensure they benefit the IVIC owners. Each owner is then assigned a number of notional fund units based on the value of their investment deposits. In Segregated funds you can open any kind of account like, RRSP, TFSA, RESP, RIF, LIRA, LIF and Annuity.

Segregated funds have a number of features that do not apply to mutual funds, including the following:

  • Have a maturity guarantee.
  • Have a death benefit guarantee.
  • They offer creditor protection.
  • They use reset options to lock in past performance and reset the guarantee periods.
  • They can bypass probate.
  • They can flow through capital losses, in addition to capital gains and other investment income, to investors. (Mutual Funds flow through capital gains and other investment income, but cannot pass on capital losses)
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What are Segregated Funds?

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. Segregated Funds issue by Insurance company with Maturity and Death benefits guarantee and guarantee can be 75/75, 75/100 and 100/100. It is based on the Segregated Funds contract term.

What are the death benefits and maturity guarantees of Segregated Funds?

All segregated Funds offer death benefits and maturity guarantees. The amount or percentage of guarantee can vary between products and offering companies. Some companies offer segregated funds with several guarantee options, while others only offer a single guarantee option. Segregated Funds are required to have a minimum 75% maturity guarantee and a minimum 75% Death Benefit Guarantee. Many companies offer up to 100% Death Benefit Guarantee, but it is less common for a company to offer a 100% Maturity Guarantee. Specifically, the Death Benefit Guarantee offers protection from losses incurred by the investor during their lifetime. The guarantee is paid upon the investor’s death. The Death Benefit Guarantee percentage is selected with the initial purchase of the contract. At the time of the investor’s death, the beneficiaries would receive the greater of the guaranteed amount or the investment’s market value. This enables the investor and their heirs to benefit from market growth while safeguarding the investment capital. A Maturity Guarantee safeguards the investment’s capital until the end of a specified time period, usually in 10- or 15-year terms. Newer segregated funds have also extended the maturity date until the investor reaches 100 years of age. With the recent turmoil in financial markets, the trend for segregated funds is to offer longer and longer maturity terms and lower (75%) Maturity Guarantees. The Maturity Guarantee ensures that the investor will receive the higher of the investment’s market value or the guaranteed amount on the date of maturity. Principal protection guarantees are typically reduced on a proportional basis by any withdrawals made from the fund

How are Segregated Funds treated for Income Tax?

Tax treatment for Segregated Funds is similar in many ways to the taxation of mutual funds, however, there are a few differences including the following:

  • Segregated Funds allocate income and capital gains/losses to contract holders each year. This is different from mutual funds, which distribute or pay out income to investors in either the form of additional units or cash payments. This allocation of income does not change the number of units held nor a corresponding drop in price. The allocations will increase or decrease the investor’s adjusted cost base. Investors in Segregated Funds are allocated income, but do not actually receive a payment or distribution.
  • A Mutual Fund cannot allocate capital losses to unit holders. Losses are subtracted from capital gains within the fund and only the fund’s net capital gains will be distributed to an investor and reported on their T3 Income Tax information slip. For a mutual fund, in a year where capital losses are greater than capital gains, the excess losses are carried forward to offset future capital gains.
  • Segregated Funds can flow through capital losses to contract holders. The capital losses are recorded on the investor’s T3 Income Tax information slip. This gives the Segregated Fund investor the advantage of taking the capital losses and applying them to other capital gains in the same year. The investor can also carry the Segregate Fund capital losses back three years and apply them to gains previously claimed and taxed.
  • Segregated Fund contracts allocate income and capital gains/losses on December 31st, regardless of the underlying fund’s distribution date. For example if the underlying mutual fund declares the distribution date as December 10th, the segregated contract will not distribute the income until December 31st.
  • Purchasers of Segregated Funds in a taxable account might consider buying the fund at the beginning of the year to avoid receiving the income tax responsibility for Segregated Fund income, even thought they did not actually receive the income benefit.

Do segregated funds have additional costs?

Segregated funds are really two separate purchases: the first is a mutual fund and the second is an insurance wrapper. The insurance coverage will increase the investment’s annual cost, it depends on the fund you choose and type of guarantee you choose. Fee can be between 0.10% to 1%. As a result, segregated funds have higher management expense ratios (MERs) than mutual funds.

What is the difference between Mutual Funds and Segregated funds?

Here are some basic difference between Segregated funds and Mutual funds

Mutual Funds
Segregated Funds
Maturity Guarantee
Death Benefits Guarantee
Bypass Probate*
Maturity Guarantee Reset*
Death benefit inflation protector*
Creditor protection*
Automatic Death Benefits Reset*