1 Segregated funds or mutual funds Do you know the differences? Although there are many similarities between these two investment products, there are also some important ways in which they differ. One important difference is segregated funds are only available through a life insurance policy. In this guide, we ll address the main differences and help you understand which might be more appropriate for clients. Each client is different; what s good for one might not be right for the next. The better you understand the differences, the better you ll be at recommending the right product for each client. This article addresses the following five areas: some tax provisions that are quite different, particularly with respect to non-registered investments. 3. Death We ll discuss naming beneficiaries and the differences that arise on the death of the owner or annuitant because of the differences in the legal character of segregated fund policies and mutual fund accounts. We ll also discuss the differences in income tax treatment on the death for nonregistered clients. 4. Fee structures We ll discuss the load structures of fees, management expense ratios (MERs) and deferred sales charges. We ll also distinguish any differences in fees between the two investment options. 5. Planning uses While the use of segregated funds and mutual funds offer professional money management for investors, there are unique features of each that appeal to different people. What are the details you should look at with a client to help them determine whether a segregated fund policy or a mutual fund account is right for them? 1. Legal Segregated fund policies and mutual fund accounts are regulated under different legislation. We ll discuss the differences in legal character, creditor issues, capital requirements, licensing, client disclosure and rescission rights. 2. Taxation Although investments in segregated fund policies are taxed similar to investments in mutual fund trusts (mutual fund corporations are also discussed in less detail), there are For more information, contact your sales and marketing centre. This material is for information purposes only and shouldn t be construed as providing legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your tax professional. This information is provided by London Life Insurance Company and is current as of February, London Life and design are trademarks of London Life Insurance Company. Reprinted with permission from London Life Insurance Company.
2 1. Legal Segregated fund policies A segregated fund policy is an individual variable insurance contract based on the life of the insured person(s), also known as the annuitant, who is named on the application form. The policy allows the policyowner to allocate units, in proportion to the premium they have paid to the insurance company and receive notional units based on the amount invested. The insurance contract between the policyowner and the insurance company gives a choice of segregated funds and provides certain guarantees. Because the policy is a form of life insurance, the policyowner can name a beneficiary. The assets of the segregated funds are owned by the insurance company and kept separate from its general assets. These assets are not available to creditors of the insurance company. The Federal Office of the Superintendent of Financial Institutions (OSFI) sets out minimum levels of capital insurers must hold as reserves to support segregated fund guarantees. As segregated funds policies are life insurance contracts, the financial security advisor must have a license to sell life insurance in order to sell segregated fund contracts. The advisor must give the client an information folder before or at the time of sale and a policy at the time of sale. These life insurance policies are regulated by provincial insurance legislation. Potential for creditor protection 1 is provided under this insurance legislation. For personally owned segregated fund policies, creditor protection can mean the policy cannot be accessed by creditors during the life of the annuitant. The potential for creditor protection may be available where the beneficiary is of a certain relationship to the annuitant, for example: spouse or common-law partner, child or parent. As well, there may be 1 Creditor protection depends on court decisions and applicable legislation, which can be subject to change and can vary by province; it can never be guaranteed. Clients should talk with their lawyers to find out more about the potential for creditor protection for their specific situations. other protections available for registered policies, under either bankruptcy or writ execution legislation. After the death of the annuitant, the benefit of insurance continues the protection from creditors, where the policyowner has named a beneficiary - the death benefit of a segregated fund policy is paid to a named beneficiary outside the estate and any creditors of the estate do not have an interest. It is unusual for any creditor to successfully go after a beneficiary, absent extraordinary circumstances. Note, a beneficiary of a segregated fund policy that s a RRSP or RRIF may have joint and several liability under the Income Tax Act (Canada) if the estate is unable to pay the income taxes relating to the amount included for the RRSP or RRIF on the final return. For corporately owned segregated fund policies, the beneficiary is generally the corporation in order to avoid any shareholder taxable benefits; therefore, the segregated fund policy is not protected against the corporation s creditors, as the corporation does not fall within one of the relationships that the legislation allows. If the segregated fund policy is owned by a holding company, it is generally protected from creditors of the operating company. Policyowners have the right to cancel the contract, an initial pre-authorized chequing premium or any additional lumpsum premium, within certain criteria. These rights have to be exercised and provided to the insurance company in writing within two business days of the earlier of the date the policyowner receives confirmation of the transaction or five business days after the confirmation of the transaction is mailed to the policyowner. The amount returned to the policyowner is the lesser of the amount of premium being cancelled or the value of the applicable units acquired on the day the request is processed. Mutual funds Mutual funds are a pooled investment in a trust or a corporation. There are no annuitants or beneficiaries to receive death benefits (although if the mutual fund is held in a registered plan, such as an RRSP, RRIF or TFSA there may be a beneficiary for the registered plan, except in Quebec).
3 Mutual fund trusts are unit trusts. The beneficial interest in the trust is divided into units. Similarly, mutual fund corporations are share corporations. Investors in the corporation own shares. The unitholder, or shareholder, actually owns an interest in the trust or corporation and is entitled to receive, on demand, an amount equal to the value of their interest in the net assets of the trust or corporation. Assets of each mutual fund are kept separate from the assets of the fund management company. 12-month period prior to bankruptcy. There may also be protection for registered mutual funds under some provincial legislation that sets out what things are exempt from seizure by creditors (e.g. BC s Court Order Enforcement Act). A beneficiary of a registered mutual fund account that is a RRSP or RRIF may have joint and several liability under the Income Tax Act if the estate is unable to pay the income taxes relating to the amount included for the RRSP or RRIF on the final return. Mutual funds are regulated by provincial securities legislation; for example, the OntarioSecurities Act. Investment representatives must be registered with a mutual fund dealer and the securities regulator to be authorized to sell mutual funds. Investment representatives must give the client a simplified prospectus (similar to the information folder) within 48 hours of the sale. Mutual fund clients also have the right of withdrawal and the right of rescission. The right of withdrawal Provincial legislation requires the client to receive a simplified prospectus before an order to buy a mutual fund is final. If the client does not receive this prospectus, the law allows the client to withdraw from the purchase, if they chose. The client is entitled to receive the purchase amount plus commissions and charges (if any) related to the purchase. The right of rescission This right allows the client to cancel an agreement to purchase mutual funds. The purpose of the right is to provide a cooling off period after a purchase. Again, not all provinces have the same rights. The client is entitled to receive the lesser of the purchase amount or the value of the mutual funds at the time they exercise, plus commissions and charges (if any) related to the purchase. There is no statutory creditor protection for non-registered mutual funds. All registered investments are now exempt from seizure or claims of creditors in case of personal bankruptcy, except for those contributions made within the
4 Summary Life insurance contract Segregated fund policies Client owns an interest in the life insurance contract; units of the segregated funds are notional Contract ends on the death of the last annuitant (measuring life) Can name beneficiaries for both registered and nonregistered policies Regulated by provincial insurance legislation Information folder must be given before or at time of sale and a policy at the time of sale Potential creditor protection for registered and nonregistered policies Mutual funds Pooled investment in a trust or corporation Client owns units of a mutual fund trust or shares of a mutual fund corporation Units/shares pass to estate or to named beneficiary of a registered plan on death Cannot name beneficiaries for non-registered plans or registered plans in Quebec Regulated by provincial securities legislation Prospectus must be given within 48 hours of sale Potential creditor protection for registered accounts only
5 2. Taxation Segregated fund policies For income tax purposes, segregated funds are deemed to be inter vivos trusts. Policyowners are deemed to be beneficiaries of the trust. Trusts must generally pay income tax at the highest tax rates on any income or realized capital gains of the trust that are not paid out to beneficiaries. For segregated funds, income is deemed to be paid to beneficiaries allowing the fund to flow out all the income and realized capital gains and losses to policyowners. One method of allocating income of a segregated fund is on a time-weighted basis (i.e., for the actual time the policyowner had an interest in the fund). This means the income is allocated to the policyowner based on how many units they have allocated to their policy and how long they were invested in the segregated fund. Since income and capital gains/losses can be allocated without actually being distributed to policyowners, there s no post-allocation drop in the fund price or change in the number of units. The policyowner s adjusted cost basis (ACB) is increased by the amount of income and capital gains allocated to the contract; and decreased by the capital losses allocated; they don t pay tax again on this amount when units are redeemed. Segregated funds are flow-through vehicles, so all income allocated retains its character. For example, Canadian dividends allocated by segregated funds are taxed as Canadian dividends in the hands of the policyowners. There are two ways a policyowner can incur capital gains or losses. If the segregated fund manager sells a stock, bond or other security, the fund may realize a capital gain or loss. Insurance companies allocate this gain or loss to the policyowners. The capital gains and losses realized on the sale of assets in the fund are handled slightly different than other types of income such as interest, dividends and foreign income. In determining the capital gain or loss allocated to the policyowner at the end of the year, the capital gain or loss amounts are first reduced by any capital gains or losses reported to policyowners who disposed units of the fund. Any excess or remaining capital gains or losses are then allocated to remaining policyowners based on their fair market value in the fund at Dec. 31. The second way a policyowner can incur capital gains or losses is if they dispose of units in the segregated fund for an amount different from their ACB. Insurance companies report both allocated and redemption gains or losses on a T3 (a Relevé 16 for Quebec residents) tax slip. The insurance company tracks the ACB of the policy for calculating the respective capital gains or losses. The amounts on the policyowner s year-end statement may not match with the tax slip as the unit value also reflects unrealized gains or losses on investments not yet disposed of. Mutual funds Mutual fund trusts Mutual fund trusts are a pooled investment and are inter vivos trusts. Income from the trust is flowed through to unitholders so the trust does not have to pay taxes at the highest tax rates. The income and capital gains of the fund is paid to unitholders and reported on a T3 (Relevé 16 in Quebec) tax slip. Fund managers distribute income and capital gains in the form of cash or reinvested units, and these transactions will be reflected on the client s investment statement. Depending on the type of fund the distributions may be monthly, quarterly or annual and are paid to unitholders on record at the date of distribution. Since income is actually being distributed to unitholders, there s a corresponding drop in the unit price. A client s ACB will increase by the amount of reinvested distributions. Mutual fund trusts are flow-through entities so distributions retain their character. For example Canadian dividends distributed by mutual fund trusts are taxed as Canadian
6 dividends in the hands of the unitholder. Where distributions by a mutual fund exceed the fund s taxable income, any excess is considered a return of capital (ROC). ROC is also reported on the T3 (Relevé 16 in Quebec) tax slip. ROC is not taxable when received, but reduces the unitholder s ACB and so will result in higher capital gains or smaller capital losses in the future when the units are disposed of. If the ROC reduces the ACB below zero, the client must report a capital gain at that time to bring the ACB back up to zero. There are two ways a unitholder can incur capital gains. If the fund manager sells a stock, bond or other security, the fund may have a capital gain or loss. As noted above, fund managers distribute a proportion of a gain to the unitholder and report it on a T3 (and a Relevé 16 in Quebec) tax slip. Unlike segregated funds, a capital loss cannot be flowed through to unitholders. Rather, net capital losses of the fund must be carried forward to be applied to future capital gains in the fund. The second way a unitholder can incur capital gains or losses is if they dispose of units in a mutual fund for an amount different from the unitholder s ACB. An exchange of units of one mutual fund trust for units of a different mutual fund trust is considered a redemption and is taxable. Gains or losses from disposal of units of mutual funds are not included on the T3 (Relevé 16 in Quebec) tax slips, and must be computed by the unitholder and reported on their tax return. To compute the amount of the gain or loss, the unitholder must calculate and track the ACB for tax purposes. Mutual fund corporations Mutual fund corporations are taxed as corporations. Investors are shareholders, as they own shares of the corporation. A mutual fund corporation is made up of a number of different funds, each of which is a separate class of shares of the corporation. Although assets and liabilities attributable to each class of shares of the mutual fund corporation are tracked separately, the corporation must compute its earnings for tax purposes as a single entity. Mutual fund corporations provide limited flowthrough of income. In general, a mutual fund corporation does not pay tax on Canadian dividends received or on net realized capital gains because it distributes enough ordinary dividends and capital gains dividends to investors to eliminate tax liability on these types of income. In effect, these types of income are flowed through to investors and treated as if investors earned them directly. Other types of income (such as interest and foreign dividends) are subject to tax in the corporation at full corporate rates. Taxable income of the corporation is reduced in part or in full by deducting expenses first. The amount of dividends and capital gains dividends are reported on a T5 (Relevé 3 in Quebec) tax slip. Any ROC distributed from a mutual fund corporation is reported on the information summary which accompanies the T5 (Relevé 3 in Quebec) slip. Any mutual fund corporation with a multi-class share structure must compute its earnings for tax purposes as a single entity. As a result, the type and amount of dividends paid to an investor in a mutual fund corporation differs from the distributions that would be paid to an investor of a mutual fund trust that made the same investments. For example, consider two funds, one with a realized capital loss and the other with a realized capital gain. If both funds were trusts, the fund with the loss carries it forward and the other fund distributes a capital gain. If the funds were classes of shares of a mutual fund corporation, the realized capital loss is applied to reduce realized capital gains of the corporation as a whole, reducing or eliminating capital gains distributed to the other classes of shares. As with mutual fund trusts, investors in mutual fund corporations must track their ACB and report any capital gains or losses resulting from dispositions of shares of the mutual fund corporation when they file their tax return. One important difference is that switches between different funds of the same mutual fund corporation occurs on a taxdeferred rollover basis and do not result in a capital gain or loss.
7 Summary Segregated fund policies Mutual fund trust Mutual fund corporation Taxable Canadian dividends, capital gains, losses and foreign income all flow through and retain their character when allocated to policyowners. Net capital losses flow through to investors and are available to investors to offset capital gains from other sources. Income is reported on T3 (Relevé 16 in Quebec). Capital gains and losses reported on the T3 (Relevé 16 in Quebec) include both allocated gains/losses and gains/losses from disposal of units. We allocate income on a timeweighted basis, except capital gains or losses are allocated first to policyowners who disposed of units throughout the year. Switches between different segregated funds are taxable dispositions. Taxable Canadian dividends, capital gains and foreign income all flow through and retain their character when distributed to unitholders of mutual fund trusts. Net capital losses and non-capital losses must be carried forward at the fund level. Income reported on T3 (Relevé 16 in Quebec). Unitholders must track own ACB and report the gain/loss on dispositions on their tax return. Income distributed to unitholders of record on distribution date. Switches between different mutual fund trusts are taxable dispositions. Only Canadian dividends and capital gains flow through to investors and are paid in form of dividends and capital gains dividends. Net capital losses and non-capital losses must be carried forward at the corporate level. Income is reported on T5 (Relevé 3 in Quebec).Clients must track own ACB and report the gain/loss on dispositions on their tax return. Income distributed to shareholders of record on distribution date. Switches between different funds within the same mutual fund corporation are not considered taxable dispositions.
8 3. Death Provincial estate taxes (probate fees) Where there is a named beneficiary, other than the estate, on the death of the annuitant the death benefit of a segregated fund policy passes directly to the named beneficiary and is not included as part of the deceased s estate for probate or estate tax purposes. In comparison, the fair market value (FMV) of the mutual fund account at the date of death is included in the deceased s estate for probate purposes. Probate is not a consideration in Quebec. For registered mutual fund accounts, such as a RRSP or a RRIF, the above applies unless the spouse or common-law partner is named the sole beneficiary and they transfer the account into their own registered RRSP or RRIF by Dec. 31 of the year following the year of death. For a TFSA, the above will occur unless a successor holder has been named, in which case the successor holder becomes the new owner of the TFSA and its contents. Income tax rules for non-registered clients Segregated fund policies For income tax purposes, the death of an annuitant results in a disposition. When the annuitant of a segregated fund policy dies, the insurance company is obligated to pay the death benefit to the named beneficiary or to the estate if there is no beneficiary and the contract is then terminated. If the policy has joint annuitants, they must be married, civil-union spouses or common-law spouses at the time of application. The joint annuitants must also generally be joint policyowners with rights of survivorship. (Where Quebec law applies, rights of survivorship means accretion and to obtain the same legal effects as the rights of survivorship, joint policyowners must appoint each other as his/her subrogated policyowner.) On the death of a joint annuitant, the surviving annuitant becomes the sole annuitant. The death benefit is only paid on the death of the last annuitant while the policy is in force. The annuitant s death is a disposition for tax purposes and the policyowner must include any capital gain or loss arising from this disposition on their income tax return. If there is a single annuitant and this annuitant dies, the contract ends. There is no ability to roll the contract over to a surviving spouse or common-law partner. If the policyowner, who is not the annuitant, dies, the policy remains in force and ownership passes to any contingent owner specified or as outlined in the deceased s will. In this situation, the Income Tax Act (Canada) deems the deceased owner to have disposed of the policy at FMV and as a result, any capital gain or loss must be reported in the final tax return of the deceased. Ownership can be transferred tax-deferred to the surviving spouse or common-law partner, provided both parties were residents of Canada on the date of death. The death of a beneficiary is not a taxable event. In this case, the policyowner of the contract should name another beneficiary. Mutual funds If a mutual fund unitholder dies (remember, there is no annuitant), the account remains in effect and ownership passes to the new owner as designated in the will. The Income Tax Act deems a disposition to occur at FMV on the date of death of the unitholder. As a result, the amount of any capital gain or loss arising from the deemed disposition must be reported in the final tax return of the deceased unitholder. Ownership can be transferred taxdeferred to the surviving spouse or common-law partner, provided both parties were residents of Canada on the date of death.
9 4. Fee structures The following chart outlines the main fees applicable to segregated fund policies and mutual fund accounts. This list is not exhaustive and there may be other fees charged by either investment. Fee Management expense ratio (MER) Segregated fund policy Mutual fund account Investment management fee Administration fee Operating expenses Advisory and management services fee Trading expense ratio (TER) Management and administrative service fee (MAS) Front-end load (sales charge purchase option) Redemption charges Deferred sales charge option (redemption charge purchase option) Low-load sales charge option (low-load purchase option) Death benefit guarantee reset fee and maturity guarantee reset fee Lifetime income benefit monthly charge Short-term trading fees Fund of funds Switch fees
10 Management expense ratio (MER) For both segregated funds and mutual funds, this ratio is the total of the investment management fees plus all expenses charged annually for the management and operation of the fund expressed as a percentage of the total value of the fund. The MER for a segregated fund is usually greater than a comparable mutual fund and may even vary by guarantee levels provided under segregated fund policies. The following fees are included in the MER: Investment management fee Represents the fee charged by the fund managers for supervising the portfolio and managing the investment funds. Administration fee Where a company acts as manager, registrar and transfer agent of the funds, directly provides the vast majority of the services required for the funds to operate and bears all of these expenses in respect of each series, it charges a fixed-rate, annual administration fee instead of the operating expenses. Operating expenses The main services charged as fund operating expenses include (if applicable) legal, audit, administration, transfer agent, custodian and trustee services, costs of financial reporting, costs of prospectus printing, regulatory filing fees and any applicable taxes. Trading expense ratio (TER) Published by mutual funds in the management report of fund performance (MRFP) starting in 2005, the TER is the amount of commissions and other portfolio transaction costs expressed as an annualized percentage of average assets during a period. Although only disclosed by mutual funds since 2005, these and all costs have always and continue to be reflected in the rates of return for all investments. Advisory and management services fee The advisory and management services fee covers the following services: Investment advice Customized portfolio design Personal performance reporting Program monitoring Other retirement and investment planning services. The advisory and management services fee is negotiated with your financial security advisor. The fee agreed upon will be based on a number of factors, including: The value of your plan The number of plans you have with us The average value of your plans with us How complex it is to administer your plan The service and support you receive from your financial security advisor Generally, the annual advisory and management services fee is between 0.50 per cent and two per cent. The minimum monthly fee is currently $150. The fee cannot be renegotiated for two years unless the value of the plan increases to the next fee level or the fee ranges change. The advisory and management service fee may be deducted from each of your plans or all from the same plan. If units are disposed of to pay the advisory and management service fee, there will be tax consequences. The advisory and management service fee plus applicable taxes will be deducted from the plan monthly. The range of the advisory and management service fee or the minimum fee may change at any time.
11 Management and administrative service fee (MAS) To compensate the investment representative, a management and administration services (MAS) fee is negotiated and charged separately to the client. The MAS (or wrap) fee is calculated at the client level and may be charged either as a percentage of assets held or as a flat dollar amount. Units may be redeemed to pay the fee, or fees may be withdrawn as an electronic funds transfer from the client s bank account. Front-end load (Sales charge purchase option) A percentage of the premium or deposit is charged as an initial sales charge, while the balance is invested into segregated funds in the policy, units or shares. No redemption charges are required to be paid when units are redeemed. Example: $1,000 premium or deposit with a front-end load of three per cent. The net amount of $970 is invested in the policy, units or shares. Typically, the front-end load is negotiated between the financial security advisor and the client and ranges from zero to five per cent. If a zero per cent rate is negotiated, no front-end or back-end load applies. Redemption charges Deferred sales charge option (Redemption charge purchase option) While there is no front-end fee when entering the policy or plan, a fee is charged if fund units or shares are redeemed within a specified period after purchase. The fee can either be a percentage of the amount redeemed or the initial contribution, and the fee rate declines over six or seven years. Example: The client redeems units after three years when their value has increased to $1,200. The applicable fee of four per cent is calculated on the amount redeemed and calculated to equal $48. The net proceeds of redemption will be $1,152 ($1,200-[$1,200 X 4 per cent]). Under a segregated fund policy, the death of the annuitant causes the contract to end and the death benefit paid out in full with no deferred sales charge. When the owner of a mutual fund account dies, ownership of the funds may be transferred to a new owner. If the new owner cashes out the funds, the deferred charge still applies. Low-load sales charge option (Low-load purchase option) Similar to the deferred sales charge option above, a fee is charged if fund units or shares are redeemed within a specified period after purchase. The fee is a percentage of the amount redeemed, and the fee rate declines over three years. Death benefit guarantee reset fee and maturity guarantee reset fee If you choose to add the death benefit guarantee reset option under a 75/100 guarantee or 100/100 guarantee policy or the maturity guarantee reset option under a 100/100 guarantee policy, you must pay an additional fee for each option. The applicable option must be selected on the application and once selected cannot be terminated. The amount of the reset fee under the applicable reset option varies for each segregated fund and from time to time. The death benefit guarantee reset fee is not included in the management expense ratio. Any applicable redemption charges will apply on the redemption of units to pay the death benefit reset fee. The death benefit reset fee will not proportionally reduce any maturity or death benefit guarantees. Lifetime income benefit monthly charge If you choose to add the lifetime income benefit option under a 75/75 guarantee or 75/100 guarantee policy, you must pay an additional monthly fee for the option. The
12 option can be selected on the application or at a later date. The amount of the lifetime income benefit fee varies for each applicable segregated fund and from time to time. The lifetime income benefit fee is not included in the management expense ratio. The redemption of units to pay the lifetime income benefit fee will not result in redemption charges. The lifetime income benefit fee will not proportionally reduce any maturity or death benefit guarantees. Short-term trading fee Segregated funds Using segregated funds to time the market or trading on a frequent basis is not consistent with a long-term investment approach based on financial planning principles. In order to limit such activities, we will charge a short-term trading fee of up to two percent of the amount switched or redeemed if you allocate premiums to a segregated fund for less than 90 consecutive days. The short-term trading fee is retained in the segregated fund as compensation for the costs associated with the switch or redemption request. The fee is subject to change. Mutual funds Inappropriate short-term trading fee A fee of 2% of the amount switched or redeemed will be charged by a fund for inappropriate short-term trading. Inappropriate short-term trading is defined as trading within a short period of time (less than 90 days) that may be detrimental to fund investors and which occurs in certain funds with securities priced in other time zones or illiquid securities which trade infrequently. Excessive short-term trading fee A fee of 1% of the amount switched or redeemed will be charged by a fund if you invest in a fund for less than 30 days and your trading is part of a pattern of short-term trading that may be detrimental to fund investors. The short-term trading fees will be paid to the fund. Fund of funds When a segregated fund or mutual fund invests in an underlying fund, the fees and expenses payable in connection with the management, operation and administration of the underlying fund are in addition to those payable by the fund. As a result, the fund pays its own fees and expenses and its proportionate share of the fees and expenses of the underlying fund, and accordingly this is reflected in the total investment management fee and management expense ratio charged by the fund. However, there will be no duplication in the payment of investment management fees in such circumstances. In the case of mutual funds, there will also be no sales fees or redemption fees payable by a fund with respect to the purchase or redemption by it of securities of another fund that to a reasonable person would duplicate a fee payable by an investor in the fund. Switch fees If you switch between the funds then you may pay a switch fee of 0-2%. This fee may be negotiable. Switch fees are not applicable in relation to certain series of securities of the funds.
13 5. Planning uses Segregated fund policies For whom are they appropriate? Segregated fund policies might be appropriate for: Clients not interested in daily management of their investments More conservative investors who are attracted to some guarantees of their original contributions Self-employed individuals and certain professionals, such as engineers, doctors, etc., who have a high degree of potential creditor and liability risks Older investors who are looking to preserve wealth Individuals wanting to maintain or create privacy Individuals that are interested in income guarantees, such as a lifetime income benefit Features Potential for creditor protection under certain circumstances, as previously discussed Named beneficiaries on registered and non-registered policies allowing money to bypass the estate and maintain privacy Death, maturity capital and income guarantees Mutual funds For whom are they appropriate? Mutual funds are very popular in Canada, with a market size in the hundreds of billions of dollars. They appeal to a broad range of investors, including: Investors sensitive to the potentially higher fees associated with segregated fund policies Clients not interested in daily management of their investments Younger clients who do not have estate planning concerns Corporations or charitable organizations looking to invest cash, without needing the ability to bypass estate fees or creditor protection Features Generally lower fees when compared to segregated fund policies Offer tax-efficient options for non-registered clients such as corporate class funds and series with return of capital distributions Other planning issues The ability of a segregated fund policy to bypass the estate provides additional benefits other than the preservation of the capital to heirs. Privacy A will is a public document and therefore anything flowing through your will is available to the public. A segregated fund policy is a contract between you and the insurance company and any amounts paid out by the insurance company are generally known only to the two parties, and not disclosed to the general public. In this regard, policyowners can maintain privacy of beneficiaries and any amounts paid out to them. Policyowners can reduce the chance of others finding out who beneficiaries are and the amounts given. Registered mutual fund accounts where a client can name a beneficiary have similar privacy benefits. In contrast, a non-registered mutual fund is part of an individual s investments held and at death these are passed on to the chosen beneficiary as designated by a will. Others could potentially find out the details of the estate and how it was distributed. Timing The average time to settle an estate is anywhere from two to five years. With a segregated fund policy, once the insurance company is notified and the appropriate documentation is received, a payment can be settled in seven to 10 days.
14 Case studies 1) Travis is 29, single and looking to invest aggressively as he begins a long-term retirement plan. Travis is not concerned about equities volatility and has expressed an interest in maximizing growth. He is employed as an information systems analyst by the federal government and has only a small amount of credit card debt. Travis is not a likely candidate for a segregated fund policy. Paying higher fees for capital guarantees and other features he doesn t need would limit the growth he s seeking. Travis is likely to be a better candidate for mutual funds. 2) Justine is 47 and owns an interior design company. Business has been very steady for a number of years and she s built a substantial investment portfolio as a result. She has a sizable nest egg and does not want to lose it. Justine may be a very good candidate for segregated fund policies. Her self-employed status and desire to protect her wealth indicates she may be interested in potential creditor protection and/or capital guarantees.
15 Summary of the major differences between segregated funds and mutual funds Segregated fund Deemed a trust for taxation purposes, required to allocate income to policyowners. Allocates fund income, and capital gains and losses. Post allocation, ACB increases. Unit values and number of units do not change. Assets are owned by the life insurance company but are separate from the general assets of the insurer. The policyowner owns a variable annuity policy. Do not offer corporate structures or return of capital series. Regulated by provincial insurance legislation. Follow guidelines set out by the Canadian Life and Health Insurance Association (CLHIA). Life insurance companies capital requirements are substantial. An information folder must be given to the investor prior to or at the time of sale. Right of cancelling the policy, which has to be provided to the company in writing within two business days of the earlier of the date of receipt of confirmation of the transaction or five business days after it s mailed. Net capital losses flow to the investor in the year they re incurred. Income (other than capital gains and losses) is allocated on a time-weighted basis and therefore based on the amount of time the investor has held the fund. Mutual funds Considered a mutual unit trust or corporation, required to pay income to the investors. If they don t, income stays within the trust or corporation and taxed at high rates. Distributes fund income and capital gains. Post distribution, the unit value drops since assets of the fund have been distributed. If distribution is reinvested, the client s ACB increases and they own more units, so overall wealth is unchanged. Assets are owned by the mutual fund trust or corporation. The unitholders or shareholders own units or shares of the trust or corporation. Offer tax-efficient options such as corporate class funds and series with return of capital distributions. Regulated by provincial securities legislation. Follow guidelines set out by the Mutual Fund Dealers Association of Canada (MFDA) Mutual fund companies capital requirements are minimal. A prospectus must be given to the investor within 48 hours of the sale. Right of rescission within 48 hours of receiving the prospectus. Net capital losses in the fund are carried forward to apply against future capital gains in the fund. Income is distributed to the unitholders on record at the date of distribution. In most cases, income is used to purchase additional units or shares.
16 Income and capital gains or losses allocated as well as capital gains realized by the client on disposition of units are reported on a T3 slip (RL16 in Quebec). Insurance company calculates the adjusted cost basis for non-registered contracts. Guarantees of principal and cash flows (some limitations). Potential creditor protection and estate by-pass for registered and non-registered policies. Spousal rollover is not available on the death of the annuitant for a non-registered contract if the deceased was the sole beneficiary. The annuitant s death results in a termination of the policy and death proceeds are paid to the beneficiary. Spousal rollover is available for registered accounts. Income and capital gains distributed is reported on a T3 or T5 slip (RL16 or RL3 in Quebec). Investors must calculate their own ACB for non-registered accounts. Statements and transaction confirmations can be used in assisting with the calculations. No guarantees of principal or earnings. Potential creditor protection and estate by-pass for registered plans only, federally and by province. Spousal rollover at death is available for non-registered and registered accounts.
Choose the right investment Segregated fund policies versus mutual funds Choose the best option for your clients investment needs Segregated fund policies and mutual funds provide clients: Professional
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