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The Difference between Mutual Funds and Segregated Funds

Both mutual funds and segregated funds are a type of investment pool. The financial assets of these pools are owned by the investors. Segregated funds are considered as insurance products sold by an insurance company and have different risks and benefits when compared to mutual funds. Only life insurance companies can provide segregated funds and these funds are managed separately from other assets of the company.

Both types of funds can hold a diverse range of financial assets. Mutual funds and segregated funds are also similar because both have units of funds which can be bought or sold and require solicitation of professional money managers to ensure that the funds earn a good return and are managed profitably.

There are also several differences between segregated and mutual funds such as:

• Guarantee of the Principal: This feature is only available for segregated funds not mutual funds. The fund ensures that 75% of the principal invested will be paid back to the policyholder at the maturity of the policy or death. The withdrawals during the period will be deducted from the principal. Therefore, the policyholder has more security with segregated funds. If the policy is given up before the guarantee period then the policyholder will only receive cash value of the contract. The principal guarantee amount can be reset. The beneficiary receives the market value of the policy or the guarantee amount, whichever one is greater.

• Designating the Beneficiary: With segregated funds the beneficiary can be protected from creditors by assigning him the status of irrevocable beneficiary. The death benefit can be paid directly to the beneficiary by bypassing the estate.

• Ownership: The purchase of segregated mutual funds does not mean that the policyholder owns the funds. The purchase is in the name of the carrier who holds the funds for the benefit of the policyholder. Mutual funds on the other hand are owned by policyholders.

• Taxation: The income from segregated funds is tax advantaged since the income allocations are taxed when the investment income is paid to the policyholder. With mutual funds, capital losses do not flow directly through to policy owners, but in segregated funds the flow of investment income is direct.

• Disposition: The units of segregated fund contract have an adjusted cost base (ACB). Acquisition fee for the fund is not added to the ACB but it results as a capital loss at the time he or she redeems units from the policy or makes a transfer. The fee is then paid as capital loss at disposition.

• Top-ups: When the guarantee of the policy is more than the market value of the policy, the company will pay the beneficiary a top-up which is similar to a capital gain and is taxed in the same manner. The top-up is a guarantee which is offset by a capital loss that results from a decrease in market value compared to the original capital invested.

• Management Expenses: The management expenses for segregated funds are higher compared to those for mutual funds.

Segregated funds should be chosen after evaluating the risks and objectives of the insured. Segregated funds are ideal in instances where credit protection is essential, benefit guarantee or the death benefit is more lucrative or the idea of resetting guarantee is beneficial for the investor. Segregated funds provide maturity benefit guarantee, death benefit guarantee, reset options, eliminate probate fees and provide deposit protection.

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