Mutual Funds.

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities.[1] The mutual fund will have a fund manager that trades the pooled money on a regular basis. The net proceeds or losses are then typically distributed to the investors annually.
Since 1940, there have been three basic types of investment companies in the United States: open-end funds, also known in the U.S. as mutual funds; unit investment trusts (UITs); and closed-end funds. Similar funds also operate in Canada. However, in the rest of the world, mutual fund is used as a generic term for various types of collective investment vehicles, such as unit trusts, open-ended investment companies (OEICs), unitized insurance funds, and A collective investment scheme is a way of investing money with others to participate in a wider range of investments than feasible for most individual investors, and to share the costs and benefits of doing so.
Terminology varies with country but collective investment schemes are often referred to as mutual funds, investment funds, managed funds, or simply funds (note: mutual fund has a specific meaning in the US). Around the world large markets have developed around collective investment and these account for a substantial portion of all trading on major stock exchanges.
Collective investments are promoted with a wide range of investment aims either targeting specific geographic regions (e.g., Emerging Europe) or specified industry sectors (e.g., Technology). Depending on the country there is normally a bias towards the domestic market to reflect national self-interest as perceived by policymakers, familiarity, and the lack of currency risk. Funds are often selected on the basis of these specified investment aims, their past investment performance and other factors such as fees.
Constitution and terminology
Collective investment schemes may be formed under company law, by legal trust or by statute. The nature of the scheme and its limitations are often linked to its constitutional nature and the associated tax rules for the type of structure within a given jurisdiction.
Typically there is:

• A fund manager or investment manager who manages the investment decisions.
• A fund administrator who manages the trading, reconciliations, valuation and unit pricing.
• A board of directors or trustees who safeguards the assets and ensures compliance with laws, regulations, and rules.
• The shareholders or unitholders who own (or have rights to) the assets and associated income.
• A "marketing" or "distribution" company to promote and sell shares/units of the fund.

Please see below for general information on specific forms of scheme in different jurisdictions.
Net asset value
The Net Asset Value or NAV is the value of a scheme's assets less the value of its liabilities. The method for calculating this varies between scheme types and jurisdiction and can be subject to complex regulation.
Open-end fund
An open-end fund is equitably divided into shares which vary in price in direct proportion to the variation in value of the fund's net asset value. Each time money is invested, new shares or units are created to match the prevailing share price; each time shares are redeemed, the assets sold match the prevailing share price. In this way there is no supply or demand created for shares and they remain a direct reflection of the underlying assets.
Closed-end fund
A closed-end fund issues a limited number of shares (or units) in an initial public offering (or IPO). The shares are then traded on an exchange or directly through the fund manager to create a secondary market subject to market forces. If demand for the shares is high, they may trade at a premium to net asset value. If demand is low they may trade at a discount to net asset value. Further share (or unit) offerings may be made by the scheme if demand is high although this may affect the share price.
The added element of market forces tends to amplify the performance of the fund increasing investment risk through increased volatility.
Gearing and leverage
Some collective investment schemes have the power to borrow money to make further investments; a process known as gearing or leverage. If markets are growing rapidly this can allow the scheme to take advantage of the growth to a greater extent than if only the subscribed contributions were invested. However this premise only works if the cost of the borrowing is less than the increased growth achieved. If the borrowing costs are more than the growth achieved a net loss is achieved.
This can greatly increase the investment risk of the fund by increased volatility and exposure to increased capital risk.
Availability and Access
Collective investment schemes vary in availability depending on their intended investor base:

• Public-availability Schemes - are available to most investors within the jurisdiction they are offered. Some restrictions on age and size of investment may be imposed.
• Limited-availability schemes - are limited by laws, regulations, and/or rules to experienced and/or sophisticated investors and often have high minimum investment requirements. Hedge funds are often restricted this way.
• Private-availability schemes - may be limited to family members or whoever set up the fund. They are not publicly quoted and often are arranged for tax- or estate-planning purposes. Private equity funds are typically structured this way.

Advantages and Disadvantages

Every investment has advantages and disadvantages. But it's important to remember that features that matter to one investor may not be important to you. Whether any particular feature is an advantage for you will depend on your unique circumstances. For some investors, mutual funds provide an attractive investment choice because they generally offer the following features:

• Professional Management — Professional money managers research, select, and monitor the performance of the securities the fund purchases.
   
• Diversification — Diversification is an investing strategy that can be neatly summed up as "Don't put all your eggs in one basket." Spreading your investments across a wide range of companies and industry sectors can help lower your risk if a company or sector fails. Some investors find it easier to achieve diversification through ownership of mutual funds rather than through ownership of individual stocks or bonds.
   
• Affordability — Some mutual funds accommodate investors who don't have a lot of money to invest by setting relatively low dollar amounts for initial purchases, subsequent monthly purchases, or both.
   
• Liquidity — Mutual fund investors can readily redeem their shares at the current NAV — plus any fees and charges assessed on redemption — at any time.

But mutual funds also have features that some investors might view as disadvantages, such as:

• Costs Despite Negative Returns — Investors must pay sales charges, annual fees, and other expenses (which we'll discuss below) regardless of how the fund performs. And, depending on the timing of their investment, investors may also have to pay taxes on any capital gains distribution they receive — even if the fund went on to perform poorly after they bought shares.
   
• Lack of Control — Investors typically cannot ascertain the exact make-up of a fund's portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades.
   
• Price Uncertainty — With an individual stock, you can obtain real-time (or close to real-time) pricing information with relative ease by checking financial websites or by calling your broker. You can also monitor how a stock's price changes from hour to hour — or even second to second. By contrast, with a mutual fund, the price at which you purchase or redeem shares will typically depend on the fund's NAV, which the fund might not calculate until many hours after you've placed your order. In general, mutual funds must calculate their NAV at least once every business day, typically after the major U.S. exchanges close.

Different Types of Funds

When it comes to investing in mutual funds, investors have literally thousands of choices. Before you invest in any given fund, decide whether the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is figuring out your financial goals and risk tolerance — either on your own or with the help of a financial professional. Once you know what you're saving for, when you'll need the money, and how much risk you can tolerate, you can more easily narrow your choices.
Most mutual funds fall into one of three main categories — money market funds, bond funds (also called "fixed income" funds), and stock funds (also called "equity" funds). Each type has different features and different risks and rewards. Generally, the higher the potential return, the higher the risk of loss.

Money Market Funds

Money market funds have relatively low risks, compared to other mutual funds (and most other investments). By law, they can invest in only certain high-quality, short-term investments issued by the U.S. government, U.S. corporations, and state and local governments. Money market funds try to keep their net asset value (NAV) — which represents the value of one share in a fund — at a stable $1.00 per share. But the NAV may fall below $1.00 if the fund's investments perform poorly. Investor losses have been rare, but they are possible.
Money market funds pay dividends that generally reflect short-term interest rates, and historically the returns for money market funds have been lower than for either bond or stock funds. That's why "inflation risk" — the risk that inflation will outpace and erode investment returns over time — can be a potential concern for investors in money market funds.

Bond Funds

Bond funds generally have higher risks than money market funds, largely because they typically pursue strategies aimed at producing higher yields. Unlike money market funds, the SEC's rules do not restrict bond funds to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards. Some of the risks associated with bond funds include:
Credit Risk — the possibility that companies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Credit risk is less of a factor for bond funds that invest in insured bonds or U.S. Treasury bonds. By contrast, those that invest in the bonds of companies with poor credit ratings generally will be subject to higher risk.
Interest Rate Risk — the risk that the market value of the bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or Treasury bonds. Funds that invest in longer-term bonds tend to have higher interest rate risk.
Prepayment Risk — the chance that a bond will be paid off early. For example, if interest rates fall, a bond issuer may decide to pay off (or "retire") its debt and issue new bonds that pay a lower rate. When this happens, the fund may not be able to reinvest the proceeds in an investment with as high a return or yield.

Stock Funds

Although a stock fund's value can rise and fall quickly (and dramatically) over the short term, historically stocks have performed better over the long term than other types of investments — including corporate bonds, government bonds, and treasury securities.
Overall "market risk" poses the greatest potential danger for investors in stocks funds. Stock prices can fluctuate for a broad range of reasons — such as the overall strength of the economy or demand for particular products or services.
Not all stock funds are the same. For example:

• Growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains.
   
• Income funds invest in stocks that pay regular dividends.
   
• Index funds aim to achieve the same return as a particular market index, such as the S&P 500 Composite Stock Price Index, by investing in all — or perhaps a representative sample — of the companies included in an index.
   
• Sector funds may specialize in a particular industry segment, such as technology or consumer products stocks.

How Funds Can Earn Money for You

You can earn money from your investment in three ways:

1. Dividend Payments — A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.
    
2. Capital Gains Distributions — The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.
    
3. Increased NAV — If the market value of a fund's portfolio increases after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment, or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an additional sales load).

Factors to Consider

Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you. But you should also consider the effect that fees and taxes will have on your returns over time.

Degrees of Risk

All funds carry some level of risk. You may lose some or all of the money you invest — your principal — because the securities held by a fund go up and down in value. Dividend or interest payments may also fluctuate as market conditions change.

Before you invest, be sure to read a fund's prospectus and shareholder reports to learn about its investment strategy and the potential risks. Funds with higher rates of return may take risks that aFees and Expenses

As with any business, running a mutual fund involves costs — including shareholder transaction costs, investment advisory fees, and marketing and distribution expenses. Funds pass along these costs to investors by imposing fees and expenses. It is important that you understand these charges because they lower your returns.
Some funds impose "shareholder fees" directly on investors whenever they buy or sell shares. In addition, every fund has regular, recurring, fund-wide "operating expenses." Funds typically pay their operating expenses out of fund assets — which means that investors indirectly pay these costs.
SEC rules require funds to disclose both shareholder fees and operating expenses in a "fee table" near the front of a fund's prospectus. The lists below will help you decode the fee table and understand the various fees a fund may impose:

Shareholder Fees

• Sales Charge (Load) on Purchases — the amount you pay when you buy shares in a mutual fund. Also known as a "front-end load," this fee typically goes to the brokers that sell the fund's shares. Front-end loads reduce the amount of your investment. For example, let's say you have $1,000 and want to invest it in a mutual fund with a 5% front-end load. The $50 sales load you must pay comes off the top, and the remaining $950 will be invested in the fund. According to FINRA rules, a front-end load cannot be higher than 8.5% of your investment.
   
• Purchase Fee — another type of fee that some funds charge their shareholders when they buy shares. Unlike a front-end sales load, a purchase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund's costs associated with the purchase.
   
• Deferred Sales Charge (Load) — a fee you pay when you sell your shares. Also known as a "back-end load," this fee typically goes to the brokers that sell the fund's shares. The most common type of back-end sales load is the "contingent deferred sales load" (also known as a "CDSC" or "CDSL"). The amount of this type of load will depend on how long the investor holds his or her shares and typically decreases to zero if the investor holds his or her shares long enough.
   
• Redemption Fee — another type of fee that some funds charge their shareholders when they sell or redeem shares. Unlike a deferred sales load, a redemption fee is paid to the fund (not to a broker) and is typically used to defray fund costs associated with a shareholder's redemption.
   
• Exchange Fee — a fee that some funds impose on shareholders if they exchange (transfer) to another fund within the same fund group or "family of funds."
   
• Account fee — a fee that some funds separately impose on investors in connection with the maintenance of their accounts. For example, some funds impose an account maintenance fee on accounts whose value is less than a certain dollar amount.

Annual Fund Operating Expenses

• Management Fees — fees that are paid out of fund assets to the fund's investment adviser for investment portfolio management, any other management fees payable to the fund's investment adviser or its affiliates, and administrative fees payable to the investment adviser that are not included in the "Other Expenses" category (discussed below).
   
• Distribution and/or Service]— fees paid by the fund out of fund assets to cover the costs of marketing and selling fund shares and sometimes to cover the costs of providing shareholder services. "Distribution fees" include fees to compensate brokers and others who sell fund shares and to pay for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. "Shareholder Service Fees" are fees paid to persons to respond to investor inquiries and provide investors with information about their investments.
   
• Other Expenses — expenses not included under "Management Fees" or "Distribution or Service (12b-1) Fees," such as any shareholder service expenses that are not already included in the 12b-1 fees, custodial expenses, legal and accounting expenses, transfer agent expenses, and other administrative expenses.
   
• Total Annual Fund Operating Expenses ("Expense Ratio") — the line of the fee table that represents the total of all of a fund's annual fund operating expenses, expressed as a percentage of the fund's average net assets. Looking at the expense ratio can help you make comparisons among funds.
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• Be sure to review carefully the fee tables of any funds you're considering, including no-load funds. Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858 — an 18% difference.

Segregated Funds

• Segregated Funds are similar to Mutual Funds but are offered through Insurance Companies. Their legal name is an “Individual Variable Annuity Contract”. “Seg Funds” as they are frequently called have been available to Canadians since 1961 but were not marketed to the public until about ten years ago. <more detail on ownership structure>
• There are several differences between Mutual Funds and Seg Funds. The primary differences are the principal guarantee on maturity and on death plus the ability to protect the funds from creditors going forward.
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• Lets look at the differences in more detail
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•  Why would you be interested?
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• The Benefits
• •  Principal guarantees at maturity and at death
• •  Market gains can be locked in and guaranteed
• •  Possible creditor protection
• •  Avoids probate with proceeds going directly to beneficiaries
• •  By Passes the will – great for succession planning
• •  Fees
• •  Investment Options are similar to Mutual Funds.
• •  The risk/return is similar to Mutual Funds
• •  Managing Risk – wraps and “fund of funds” portfolios
• •  Taxation
• •  Leveraged Investments with Segregated Funds
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• The Maturity Guarantee
• The maturity guarantee will guarantee that if the policy owner cashes in their policy at some future date (usually ten years) then they are guaranteed to receive the greater of the net investment or the current value, whichever is greater. The guarantees offered by each company can be very different and can be an important consideration in the choice of company and funds depending on the reasons for choosing Segregated Funds.
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• Death Guarantees
• Death guarantees are similar but do not have a time requirement as the principal is guaranteed on death. This can be a very useful estate planning tool as one could pass away in a down market.
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• Protecting Market Gains
•  ** Resets ** This is another potentially significant difference with Mutual Funds depending on the guarantee. Either twice a year or on the policy anniversary date; there is an option to lock in all the gains to date which resets the 10 year guarantee at a higher level. There are significant differences between companies for resets and it is important to understand these differences as it can make a substantial difference in the value of your investments in ten years.
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• Avoids Probate
• Avoids probate - it is an insurance product. The proceeds of the policy flow to the beneficiaries without going through probate which could provide a significant savings as well prevent attacks on these funds from disgruntled beneficiaries that could come if they passed through a will.
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• Creditor Protection:
• Creditor protection is offered as it is an insurance product. Provided that the investment is made before any creditor issues are apparent and the decision is a sound investment decision, then the creditor protection applies. Please refer to the side bar “creditor protection” for more discussion on this.
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• Fees
• Fees for a segregated fund are higher than a similar mutual fund and are made up of two components. First is the management/operating expenses and the second is the insurance costs to cover the capital protection in the guarantees. The insurance companies are required by the regulators to set aside a reserve for the guarantees they offer in the segregated funds and the fee charged for the guarantee is based on the guarantee offered. For many people, they are more interested in the creditor protection or the death guarantee (eg the person dies at a down market) so the insurance companies recently introduced different death and maturity guarantees – 75% and 100% with the lower guarantee having a lower associated fee. The 75% is more common on maturity guarantees to keep the fees down while 100% is more common on death guarantees. In addition, the sale of segregated funds has quadrupled over the years and thus some companies have reduced their management fees. Fees are now frequently less than half a cent different from the similar mutual funds.

Ownership Structure
Segregated Funds are a deferred annuity contract between an insurance company and a policy owner. The policy owner makes deposits through the contract and the insurance company invests the money in Segregated Funds. Segregated Funds are an asset of the insurance company and are similar, in essence, to money held in trust for the investor. The segregated nature protects the investor against the insolvency of the insurance company.
Mutual Funds, are owned by the investor and are managed by the investment management company. The securities in the funds (owned by the investor's pooled resources) are maintained in safekeeping by the custodian of the fund.
Maturity Guarantees
While each company is a little different, they are essentially either 100% or 75% of the deposits less any withdrawals. However, there are some very significant differences on how they are applied. Many are deposit based which means that if a deposit every year they end up with a series ten, 10 year guarantees. The other is Contract Based and few companies offer this now as it can result in higher guarantee payouts. Contract based means that all the deposits mature at the end of the10 year period.
Example: Maturity Guarantees Assumptions:
Deposit frequency is annual on January 1st over ten years
Amount is $5000
Guarantee is 100%
Deposit Date Based.
After 10 years the guarantee is $5000 as that is all that has been on deposit for the ten years. After 11 years, the guarantee will be another $5,000.
Contract Date Based
After 10 years the guarantee is $5,000 times 10 deposits or $50,000. Clearly, if this is an important factor, then select a company that offers a contract based guarantee and there are only two that offer this now. Let us help you select the right one.
Death Guarantees
Death Guarantees are one of the primary reasons for the growth in Seg Fund sales. This feature guarantees that should the annuitant pass away and the market is down from when they purchased the funds or more importantly did a reset, the difference is guaranteed to be made up.
Two situations where this is useful: if you are looking after a Senior's estate and are frustrated by the low returns of a GIC, you can invest in a conservative Seg Fund and there is no risk that you will loose any money should the senior pass away when the market is down. Better yet, if the market goes up, you can reset the guarantee and lock in the profits (see the reset discussion to follow)
Another use is for leveraging which we will also discuss later. But if the borrower dies and the market is down, again the estate does not make up the difference, the insurance company does and the small extra fee is excellent insurance value. I like to sell Segregated Funds for leveraging as it is a long term hold and one never knows when the market will take a downturn. The last thing I want to do is see a widow and ask her for money to make up the difference between the loan and portfolio value.
Guarantee Resets
Clients have the ability to restart the 10 year maturity guarantee at a chosen higher market value of the investment which has the same effect of selling a contract and immediately re-purchasing the same, but it does not trigger a disposition (capital gains) nor potential surrender fees. It resets the death benefit guarantee as well.
Reset terms also vary from company to company. Some do not reset unless the advisor directs it, another does one atomically every year on the deposit anniversary date. This is good if the advisor does not do resets as they are at least done every year, but the timing may not be the best and there is no manual reset allowed. A very few allow for up to two resets a year at any time.
Our systems make it very easy to do a reset. We ask you to sign a permission sheet and then we will email you when we feel it is a good time to do a reset and all you need to do is reply to the email within three days with your authorization to do so.
The death benefit ultimately paid will be the greater of the market value or the most recent Death Benefit Guarantee Amount. The example below is on a segregated fund with a 100% guarantee upon death. In the following example, two resets are done as the market reaches new highs. While we do not know the exact peak of the market, with two resets a year, one can use them to set it on the way up. After it is reset at $33,000 June 1, 2007, the market value of the fund(s) drops to $29,000 by October 15, 2009 when the annuitant (person) dies.
There is a significant difference between Mutual Funds and Segregated Funds. The Seg Fund guarantee was reset at $33,000 and the insurance company makes up the difference between the $29,000 market value and the $33,000 guarantee or $4,000. With a mutual fund, the estate would receive the market value of $29,000. These funds are paid out to the beneficiaries within a few weeks of the company getting the death certificate with no wills variation problems or probate fees. Mutual Funds are paid into the estate if not transferred directly to the spouse.
Having identified the advantages of resets, ask your agent how many times he does this. On average only about 15% of advisors actually do resets and of these only 5% do it more than once a year based on the stats from one of the leading funds.
Age restrictions on Death Benefit Guarantees
Typically, companies reduce the amount of the Death Benefit guarantees after the client reaches the age of 75 or older. Some may also restrict the ability to make Segregated Funds deposits after a certain age (typically 75). This reflects the increased risk of sudden death experienced with increasing age
This is where we can help as one company maintains 100% death benefit guarantee throughout the life of the contract with a reasonably generous definition of what age they will still issue it at. If that is an important consideration for your planning please ask about it.
Succession Planning and Probate – Huge Differences Mutual Funds:
Will be a part of the deceased's estate and distributed according to the will after the will is probated (fees)
Segregated Funds:
Segregated Funds are insurance contracts and a beneficiary can be named to receive any proceeds upon the death of the life insured which leads to the following benefits:

• can bypass the estate (and probate) through a named beneficiary designation.
• Privacy preserved
• The fund will not form part of the value of the estate (no probate fees or other fees like accountants, executors and lawyer fees )
• Money liquidated and received by beneficiary typically much quicker
• Not subject to the settlement of the estate
• Not typically subject to the estate creditors' claims if the named beneficiary is a member of the family like spouse, parent, child or grandchild.

Many people find that the higher costs involved are offset by the peace of mind of knowing regardless of what the market does, they can't lose their money as long as they stay the course until they reach the maturity date
There are two basic types of funds – those run by the Insurance Company itself and “clones” of actual Mutual Funds. The MER's can be between 17 and 175 basis points more than a Mutual Fund where 100 basis points equals one percent. Those that are run by Insurance Companies themselves will tend to be on the lower end. We can help you asses the value of the additional costs versus the benefits and returns. There are many good options where the additional fee is only about 0.5% which, for many, is a small premium for the additional benefits. This is supported by the surge in the purchase of Segregated Funds.
Example: Potential Estate Fees Segregated Fund Savings
Savings - $150,000 GIC at Financial Institution @ 4.0 % annual return and an estate valued at over $50,000 for probate fees.
Mutual Funds
After both you and you spouse, if any, have passed on, and your Mutual Funds are left to the beneficiaries through a will, your estate could face some or all of the following fees in addition to taxes.
•  Potential Executor Fee* $150,000 times 1.5 % = $2,250
•  Probate Fees on Estate $150,000 times 1.5 % = $2,250**
•  Legal Fees on Will Distribution** $150,000 times 1.5 % = $2,250
•  Accounting Fees* on final Tax returns** $150,000 times 1.0 % = $1500
Total fees = $8,250
* Ontario is $15 per $1,000 and B.C. is $14 over $50,000 – used 15%
** Actual fees can vary from none to more than this – used as an example
Segregated Funds
After both you and you spouse, if any, have passed on, and you're Segregated Funds are left to selected beneficiaries through the beneficiary selection on the contract:
•  Potential Executor fee 0 %
•  Probate Fees 0 %
•  Legal Fees* 0 %
•  Accounting Fees* 0 %
Total fees = 0 - A saving of $8,250
The differences continue as a will is a public document, which means anyone who wants to can see your Will know all about your affairs. In addition, funds are not dispersed until the will is settled and any children or people identified in the will can dispute it and tie it up in courts for months or even years.
When you name a beneficiary to a Segregated Fund, creditors cannot go after the beneficiaries for any monies owed by you when you pass away. Also, the death benefit is paid out directly to the named Beneficiary usually within 6 to 10 business days after the Insurance Company receives the proper death documentation,
In addition, with the death benefit guarantee, the funds could have been invested in a fund that generated a higher return than 4%.
Finally, the tax paid by the estate will likely be less as the GIC income is taxed as interest income – the highest rate. The seg fund would have had some capital gains and dividend income and the gains would be taxed at a lower rate again offsetting the higher MER – see below.

Taxation
A segregated fund is considered a trust for tax purposes. This is important for two reasons:

• The segregated fund will allocate all taxable income and realized capital gains to investors. This avoids having income taxed inside the fund at the top marginal rate.
• The fund acts as a conduit, that is income and capital gains retain their characteristics as they flow through to the investor and appear on the T3 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.

There are two taxable events arising from investing in funds – Mutual Funds or Segregated Funds

• Income allocation (controlled by company)
• Disposition (controlled by investor)

We will also talk about the impact of acquisition costs and easy of accounting for taxation at the end.
Income Allocation:
Different and yet the same
Mutual Funds will “flow through” the income to the individual investor. The investor may physically receive the income or it will be reinvested to purchase more units.
With Mutual Funds, you could be taxed on income you never received as taxation is based on who owns the mutual fund units on a given date at the end of the income period.

• E.g. if you buy units one day before the end date, you are assessed for all income earned in that period, even though you did not benefit from that income .

Segregated funds will retain and reinvest the income internally and, adjust the unit value to reflect the income distribution. The investor does not receive the income in the form of a physical payment.
With Segregated Funds, you are only taxed on the income you actually receive as taxation is based on how long you own the Segregated Fund units within the income period.

• E.g. if you buy units one day before the fixed date, you are only assessed for one day's income. The unit seller is assessed for income made before the end date.

Capital Loss
Another segregated Fund advantage since Mutual Funds cannot distribute negative capital gains distributions. Capital losses are carried forward to be used against future gains within the fund.
Segregated Funds have the ability to flow through capital losses (138.1(3) of the Income Tax Act) to the individual investor (which can in turn be used to offset other capital gains realized in the same year)
In a year, for example, where there are both capital gains and losses to report, gains will be reported in the capital gains box (Box 21-- same as a mutual fund) and losses will be reported in the "Insurance Segregated Fund Capital Losses" (Box 37 -- only available to Segregated Funds).
With Segregated Funds, the investor gets to choose when to claim the capital losses as capital losses not used in the current year can be carried back three years or carried forward to future years. This is not the case with Mutual Fund investments.
One cautionary point that I have never seen mentioned anywhere else but did occur to one of our clients. Taxable gains are the responsibility of the estate not the beneficiary.
Capital Gains
Income through disposition is treated equally in both Segregated Funds and Mutual Funds unless it is a death claim.
Example: Capital Gains on a death claim are different with a Seg Fund.
I have never seen a discussion on this elsewhere but it happened to one of our clients. One of our clients passed away from an automobile accident in her mid 20's. She had a seg fund worth about $12,000 when she passed away and had named a beneficiary with who she was no longer talking but had not changed it. The funds were paid out within weeks and there was nothing that could be done to prevent it although the executor, her father, did not want it to happen. In all cases, the beneficiary must be current.
More importantly, the capital gains that had been earned on the fund flowed through to the estate and had to be paid out of the estate. We contacted the beneficiary, to at request a cheque to cover this but it was not forthcoming and there was no recourse. This has interesting implications.
Acquisition Costs
For accounting purposes, acquisition fees are excluded from the adjusted cost base and treated separately while for Mutual Funds, acquisition fees are included in the adjusted cost base.
Segregated Funds report all taxable events – easier accounting
Another advantage related to Segregated Funds is that the insurer tracks the cost base for each investor and all taxable events are reflected on a T3. There is no additional accounting required by the investor.
With a mutual fund, only the distributions relating to fund activity are reflected on the investor's T3. If an investor redeems any of their units, they must calculate the gain and loss and report these on their tax return