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Segregated Funds VS Mutual Funds

A comparison between Segregated Funds and Mutual Funds, and the advantages of Segregated Funds.
What exactly is a Segregated or Mutual Fund?

 

Segregated Funds and Mutual Funds do share many of the same benefits, including

  • Low-cost professional management
  • Instant diversification
  • Low minimum investment requirements
  • Wide variety of investments available
  • Customizable risk levels

Whether you invest in a Segregated Fund or Mutual Fund, both are a basket of investments that could include stocks, bonds, Treasury Bills, shares of Canadian, U.S. or foreign companies or other investment vehicles. However, Segregated Funds combine the growth potential of Mutual Funds with the security of insurance. When you invest in a Segregated Fund, you are actually buying an Insurance Policy Contract. The money from each contract is then invested in an underlying Segregated Fund. You pay premiums that “deposit” money into a Policy that further invests in the Segregated Fund. When you “purchase” a Mutual Fund, you are buying units of that fund indirectly obtaining “ownership” of any securities held by that Fund.

The terminology and differences between a Mutual Fund and a Segregated Fund policy may seem superficial, but here are six Segregated Fund Policy benefits worth noting:

Maturity Guarantee

With a Segregated Fund, you are guaranteed that you will get back at least 75-100% of your original investment at a designated maturity date regardless of how markets perform. Some Segregated Funds include a “reset” feature, which allows the investor to lock in the investment gains and reset the minimum guaranteed amount at a higher level although this will extend the maturity date. Mutual Funds do not have these guarantees. If your fund drops in value by half, you will either have to sell it for a loss or wait for it to recover.

  • Advantage: Segregated Funds

Death Benefit Guarantee

With a Segregated Fund, if you die, your named beneficiary will receive the greater of your Segregated Fund value or the guaranteed value at the time. The guarantee death benefit like the maturity guarantee value can vary between 75-100% of your original deposits. There is no maturity date for this guarantee-it is effective from the day you buy the policy. So if you die, you know all of the money you invested will go to your beneficiaries immediately. Mutual Funds do not have these guarantees

  • Advantage: Segregated Funds

Creditor Protection

Since the Segregated Fund Policy is established under life insurance legislation, they are usually protected from creditors if one faces a lawsuit or bankruptcy during the policyholder’s lifetime. As long as you are not trying to defraud your creditors by moving money into a Segregated Fund immediately before or just after you have become insolvent, AND you have named a beneficiary, your investment will be safe from unexpected lawsuits and potential creditors. Even after the policyholder’s death, all beneficiaries are protected against claims made by the policyholder’s creditors. A named beneficiary also allows you confidentiality. Mutual Funds do not have beneficiaries.

  • Advantage: Segregated Funds

Estate Planning

When a Segregated Fund policyholder dies with a beneficiary designated on the policy (outside the estate), the fund is exempt from probate or estate taxes and executor fees. Unlike Mutual Funds, which are subject to these taxes and fees, investments in Segregated Funds pass directly to a beneficiary. This enhances your estate by avoiding costly delays helping you preserve your investments for your beneficiaries, and reduce the amount that will be paid to lawyers and the government.

  • Advantage: Segregated Funds

Taxation Benefits

Mutual Fund income is distributed either by cheque or by automatic reinvestment semi-annually or annually regardless of how long you have held units in the fund. That means you could end up paying tax on income that was received when you did not even own the fund! Many Segregated Funds allocate income to each unit holder on the basis of their exact share of the funds’ income earned for the period that they actually owned the fund.

 

When a Mutual Fund makes a distribution, the unit price will drop by the same amount of the distribution per unit but you will now own more units. However, in a Segregated Fund, all income is reinvested and reflected through an increase in the unit price.

 

Both Mutual and Segregated Funds issue yearly T3 or T5 Investor’s slips, which details gains and losses, and the amount of tax owing. When it comes time to redeem your fund, Segregated Fund holders will receive a T3 slip showing all income reported from previous years so that no additional calculations are necessary. Mutual Fund holders do not receive this slip and must calculate the gain or loss themselves keeping in mind that they have been purchasing units at different prices and have already paid taxes on those gains.

 

Lastly, capital losses within a Segregated Fund are allocated to its investors, which can be used to offset gains from ANY other source in the previous three years or carried forward indefinitely. Capital losses within a Mutual Fund are maintained within the fund and can only be used to offset future capital gains within that fund.

  • Advantage: Segregated Funds

Assuris 85% minimum $60,000 Guarantee

Assuris (formerly the Canadian Life and Health Insurance Compensation Corporation) provides a policyholder up to 85% of but not less than $60,000 on the guaranteed accumulated values for Segregated Fund Policies that contain maturity and death guarantees. Unlike a Mutual Fund Company, should ever there be a financial problem with a Life Insurance Company, Assuris will step in and provide some benefit to you, the Segregated Fund policyholder.

  • Advantage: Segregated Funds

To summarize then, Segregated Funds unlike Mutual Funds offers:

  • 75-100% Maturity Guarantees of your deposits
  • 75-100% Death Benefit Guarantees
  • Streamlined and simplified taxation of growth
  • Creditor Protection
  • Enhanced Estate Preservation
  • Assuris 85% minimum $60,000 policy guarantee in the event of company collapse

Some financial planners have noted that Segregated Funds come with higher MERs than Mutual Funds. MERS are the management fees charged to the investor every year. Fortunately for the investor, this is not the case. There are many Segregated Funds who have fees that are the same, slightly higher or even slightly lower than equivalent Mutual Funds. And with those six benefits, that is a valuable advantage to you.

  • Advantage: Segregated Funds