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Segregated fund tax advantages

Understanding similarities and differences compared to mutual fund trusts.

John Natale, LL.B., BComm, EPC, CFP

Head of Tax, Retirement & Estate Planning Services

John is the Head of the Tax, Retirement & Estate Planning Services, Wealth team at Manulife. He and his team provide case-level support on tax, retirement, and estate planning matters to advisors across the country.

While the taxation of segregated fund contracts is similar in some ways to the taxation of investments in mutual fund trusts, there are some differences that are advantageous to investors.

Taxation similarities

Both flow-through all taxable income and realized capital gains to investors. This avoids having income taxed inside the fund at the top marginal rate. Both act as a conduit in that income and capital gains retain their characteristics as they flow through to investors and appear on the T31 in the same way they were realized in the fund. In other words, dividends will be reported as dividends, interest as interest, and so on.

Taxation differences - Flow-through of capital losses

A mutual fund can’t flow-through capital losses. Rather, losses are subtracted from the capital gains within the fund and only the net capital gains will be distributed to an investor and shown on the T3. In a year where losses are greater than gains, the excess losses can’t be distributed and are carried forward to offset gains in a future year.

Segregated fund contracts can flow-through and report capital losses to investors. For example, in a year where there are both capital gains and losses to report, investors will have an amount reported in the capital gains box (box 21 — same as a mutual fund) and an amount in the Insurance Segregated Fund Net Capital Losses box (box 37 — only available to segregated fund contracts).

Segregated fund advantage:

Capital losses not used in the current year can be carried back three years or carried forward to future years. In other words, an investor, not the fund, chooses when to claim any excess capital losses.

Taxable events reported

With a mutual fund, only the distributions relating to fund activity are reflected on an investor’s T3. If investors redeem any of their units, they must calculate the gain and loss themselves and report these on their tax return.

 Segregated fund advantage:

The insurer tracks the cost base for each investor and all taxable events are reflected on a T3. There’s no additional accounting required by an investor.

Estate benefits

Segregated fund contracts are insurance (annuity) contracts and, as such, a beneficiary can be named to receive any proceeds on the death of the life insured (annuitant). This means the proceeds are paid directly to the beneficiary and don’t flow through the estate, and therefore, will avoid legal, estate administration, probate2, and other fees associated with the settling of an estate.

To get the same benefit of bypassing the estate, mutual funds are often held in joint ownership,3 particularly with spouses, even though the assets may belong to only one of the owners. When one owner dies, the assets automatically become the property of the other owner. The drawback to these arrangements is that the signature of both owners is required for many transactions.

Under Manulife segregated fund contracts, any revocable beneficiary can be named without affecting the ability of the owner to manage the account. The beneficiary can also be changed at any time without the beneficiary’s consent. Joint ownership of a mutual fund can’t be changed unless both owners agree.

Creditor protection

Creditor protection may also be available if the named beneficiary is a member of the family class or an irrevocable beneficiary. In provinces other than Quebec, a family class beneficiary would be any of the spouse,3 child, grandchild, or parent of the annuitant. In Quebec, a family class beneficiary would be any of the following: the married or civil union spouse, or descendants or ascendants of the policyholder.

Important Disclosure

1 Residents of Quebec will also receive an RL-16 tax slip. 2 The probate process and fees don’t apply in Quebec. There’s a verification process for non-notarial wills but not for notarial wills. 3 Joint ownership with right of survivorship doesn’t apply in Quebec. 4 For creditor protection, the definition of spouse may include a common-law spouse or same-sex spouse, depending on provincial legislation.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. The Manufacturers Life Insurance Company is the issuer and guarantor of contracts containing Manulife segregated funds. Any amount allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

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