Segregated Funds Vs Mutual Funds

While both segregated funds and mutual funds are popular choices for investors, they aren’t the same thing. Mutual funds are a way for investors to combine all of their money together in a fund managed by an investment firm. This limits exposure, which can help mitigate any risks. Segregated funds are similar except for the fact that they have insurance guarantees that can help protect your funds. 

Segregated Funds Vs EFTs

While Segregated Funds and EFTs are similar, they aren't the same thing.

EFTs: These also known as Exchange-Traded Funds, are similar to mutual funds. They allow investors to pool their money into a diverse basket of securities. The ETF is then traded on the stock market like a traditional stock. The idea behind an ETF is to track a specific index, which means there is no guarantee on your investment, and you're taking a risk with your investment. 

Segregated Funds: They work similarly to this, except they’re not a public security like an ETF. They have an insurance aspect that guarantees your fund. This makes them much more secure than a mutual fund or an ETF. However, the growth market is smaller than that of an ETF or a mutual fund. 

How Segregated Funds Work

Segregated funds are different from your traditional investments. In fact, they aren’t really investments at all. Segregated funds are offered through Canadian insurance companies and are technically considered to be an insurance product. They allow you to combine capital appreciation and life insurance through something referred to as deferred variable annuity contracts. 

These types of funds differ from traditional insurance products because they allow those who invest to get anywhere from 75% to 100% of their insurance premiums returned. These types of accounts tend to be managed by insurance companies in separate accounts, and they aren’t able to be traded on public markets. 

Unlike traditional investments, segregated funds are structured differently as well. They are contract investments, and you don’t just own partial shares of them. Due to this, you do have to hold the funds until they reach their maturity date. However, there are different types of segregated funds to choose from, so you do get a say in the terms as well as the payments. 

An Example of Segregated Funds

While there are many different types of segregated funds out there, the most common are the ones that insurance companies use. This type of segregated fund guarantees you up to 100% of your investment back once your policy reaches maturity. The specifics, though, are based on the specific terms of your segregated fund. However, many banks also offer GIFs (Guaranteed Investment Funds), which are also considered segregated funds. 

Returns of Segregated Funds Vs Mutual Funds

As we’ve already mentioned, segregated funds are considered more of an insurance product than an actual investment tool. Mutual funds, however, are considered investment tools and are traded on the public market. They’re commonly used for retirement investments and can be invested in registered and non-registered accounts. 

When it comes to mutual funds, you get to choose your risk level. Those who aren’t looking for long-term investments tend to choose a lower risk, while those who invest long-term choose higher-risk mutual funds. Another thing to consider is that, unlike mutual funds, segregated funds have almost no risk to the principal investment compared to mutual funds. Still, you can’t access them until they reach maturity. Usually, this is with a death benefit guarantee, meaning you don’t actually get the funds, but your beneficiary does. 

Fees for Both Types of Funds

With both mutual funds and segregated funds, there are going to be fees. Whether you invest with a big company like Royal Bank, large insurance companies, or even professional portfolio managers, these fees are something you need to consider. With mutual funds, the fees are primarily charged through the MER or Management Expense Ratio. Since market value and market fluctuations can already impact your current market value, MERs can cut into your profit margins.

Even though the current market value of segregated funds works differently from that of mutual funds, they also charge an MER. However, this MER is often a few percentage points larger than that of a mutual fund. This MER often covers unique costs like estate planning features and principal protections, which are some of the key differences between these two funds. 

Disadvantages of Segregated Funds

One of the largest disadvantages of segregated funds through an insurance company is the higher fees. Because it’s technically an insurance contract, there are major penalties and the potential loss of the guaranteed amount of your original investment if you try to withdraw your funds early. There are also limited investment options with segregated funds, which can be difficult for those with a large investment portfolio. 

Advantages of Segregated Funds

Segregated funds are a great way to distribute wealth through investments to a named beneficiary. Here are some advantages as to why investors choose them.

• They reduce the risk of probate fees and let the beneficiary receive more of the funds upon death.
• With a maturity guarantee or a death guarantee, either the beneficiary or the investor will receive the investor's funds with little to no risk.

It’s a great choice for capital protection, creditor protection, and a quick settlement upon death. 

How Tax Works on Segregated Funds

Taxes on segregated funds work similarly to those of other investments. However, because it’s an investment tool as well as an insurance contract, the investor is responsible for all taxes, not the beneficiary. The type of taxes that need to be paid depends on how your fund works. Depending on the investment you could have dividends or capital gains and losses.

Dividends : Just like with most investments, any interest income is fully taxable. In some cases, you may have eligible dividends that are taxed as usual (based on the grossed-up value) and capital gains that have their own capital gains tax. The main difference between the taxes on segregated funds and mutual funds is when it comes to capital losses. These are recognized and contained within a mutual fund, but this isn’t the case with segregated funds. 

Capital Losses: For capital losses, with segregated funds, you actually have a choice on what you wish to do with them. You can choose to carry them forward to another tax year, use them towards any of the 3 previous tax years, or claim them on your current tax year. Either way, you’re able to claim them. 

The Best Segregated Funds in Canada

While it can be challenging to choose, there are actually many insurance companies in Canada that offer some of the best segregated funds. These companies include:

• Industrial Alliance
• Canada Life
• Manulife Investment Management
• Royal Bank
• Sunlife

These are just to name a few, though. There are a ton of different segregated funds to choose from, and a financial advisor can help you pick the best one for you.  

Final Thoughts

Investing can be difficult. There are so many different investment options out there, and each one has its own pros and cons. Depending on your life and financial situation, all of these investment options might not be a good fit for you. However, for those looking into life insurance, a good option might be segregated funds. These funds can be given to a beneficiary after you pass away, or, depending on your contract, you can receive the funds back once they reach full maturity. 

Segregated funds are actually a really popular alternative for those looking into investing for the future, and not just retirement. It’s also a way to avoid or reduce probate fees when you’re creating your will. However, speaking to an advisor can help you determine what the best option for you is.