Understanding Segregated Funds

Investors seeking safety and guarantees often have segregated funds in their non-registered investment portfolio. Segregated funds are mutual funds wrapped up with a life insurance policy to provide a death benefit as well as a guarantee of principal.

They are an attractive alternative for investors who want creditor protection and a guarantee of value. 

The money is held in trust and income is distributed to the beneficiaries and then generally immediately reinvested, much like mutual fund distributions. Income allocations do not affect the value of the segregated fund, unlike mutual funds. In addition, losses can be flowed through to the segregated fund holder to offset other capital gains.

Insurance segregated funds also differ from mutual funds primarily in that they offer maturity and death guarantees on the capital invested and specifically, reset guarantees—the ability to lock in market gains. This is usually 75% to 100% of the amount invested, which will be returned to the taxpayer on death or maturity.

Depending on the insurer, a reset can be initiated by the investor two to four times per year. The guaranteed period on maturity is usually 10 years after the policy is purchased, or after the reset. There are no tax consequences at the time the accrued gains in the investment are locked in by way of reset.

How are these guarantees reported on the tax return on maturity of the fund or death of a taxpayer? That’s the subject of Part 2 and Part 3 coming your way in our future editions.

Excerpted from Jacks on Tax by Evelyn Jacks. The 2014 edition will be available in December and is now available for pre-orders at the Knowledge Bureau bookstore.