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Investments, Tax Planning

Segregated Funds vs. Mutual Funds

Jeff Graham, CFP, CLU

While a segregated fund (also known as a Guaranteed Investment Fund) and a mutual fund share many similarities, there are key differences between the two; here are the components investors should be aware of

Similarities:

  1. Investors pool their money together in a professionally managed investment fund.
  2. Investors get to select the type of fund their money goes into, gaining exposure into a wide variety of sectors and geographic regions.
  3. Investors pay a management fee directly to the investment company and are automatically deducted from the investment value. A net return on an investment includes the investment performance minus the management fee.

Primary Differences:

  • Beneficiary Designations
Segregated funds are governed by insurance legislation and are formally known as Individual Variable Insurance Contracts. This means that they gain access to some crucial perks such as the ability to name a beneficiary on non-registered assets. Naming a beneficiary on non-registered accounts is not traditionally allowed with mutual funds.
 
What’s the advantage to naming a beneficiary directly on investment accounts?
 
The ability to bypass the will and therefore the lengthy, costly and complex probate process. This provides liquidity and confidentiality for the investor and beneficiaries. Additionally, segregated funds offer maturity and death benefits guarantees. This provides further protection to investors against market downturns.  However, segregated funds generally result in higher fees than mutual funds. It is important for investors to evaluate the different investment options. You should base your decisions on holistic and individual circumstances, goals and objectives, and weigh the pros and cons.
  • Fees

Segregated funds typically have higher fees than mutual funds, due in part to the contractual guarantees they include. More on this below.

  • Contractual Guarantees

Segregated funds come with built-in principal and maturity guarantees. The investor can choose from 75 or 100% guarantees on maturity or death. For example, a 100% death guarantee would mean if an investor passed away while the investment had dropped in value from where it started, the segregated fund would be “topped-up” to 100% of the starting value. These guarantees are a primary reason for the fee discrepancy between mutual funds and segregated funds. As expected, the fees for a 75/75 maturity and principal guarantee are lower than a 100/100 guarantee.

  • Taxation

There are subtle differences with the annual tax reporting, which comes in to play on non-registered accounts. While the specifics are beyond the scope of this article, the main component to be aware of is segregated funds allocate capital losses directly to contract owners. With mutual fund trusts, the capital losses within the fund are used to offset any capital gains. Many tax experts view this as an advantage for segregated funds.

Are mutual funds or segregated funds better for me?

Are the built-in benefits of segregated funds worth the higher investment fee? That’s the ultimate decision for investors to make. For a detailed discussion about the pros and cons with segregated funds and mutual funds or to open an investment account, please contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.

DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.

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