4.1 Types of Segregated Funds & Fund Analysis
Key Takeaways
Segregated funds come in the same categories as mutual funds: money market, bond, income, mortgage, equity, dividend, real estate, balanced, index, fund of funds and specialty funds.
Risk and expected return rise from money market and mortgage funds through bond, income and balanced funds to equity and specialty funds.
A fund of funds invests in one or more underlying funds; if one underlying fund makes up 50% or more of the assets, the Fund Facts show that fund's top 10 holdings.
In a non-registered contract, allocations and gains on switches or withdrawals are taxable; in a registered contract, tax arises only when money leaves the plan, with withholding tax on RRSP withdrawals and on RRIF amounts above the minimum.
Fund analysis compares the insurer's offerings (funds, guarantee levels and fee series) with the client's objective, risk profile and time horizon.
Types of Segregated Funds and Fund Analysis
A segregated fund contract is a wrapper; inside it, the client chooses one or more segregated funds, each a pool of investments with its own objective. The curriculum lists the main types, and exam questions expect you to match a fund to a client.
1. The Fund Types
| Fund type | Main holdings | Objective | Risk | Typical client |
|---|---|---|---|---|
| Money market | Treasury bills, short-term deposits and commercial paper (under one year) | Capital preservation and liquidity | Lowest | Short horizon, parking cash, very risk-averse |
| Mortgage | First mortgages on residential and commercial property | Steady income with low volatility | Low | Conservative income seekers |
| Bond (fixed income) | Government and corporate bonds | Income and some capital gains | Low to medium; interest rate and credit risk | Income needs, diversification for equity investors |
| Income | Bonds plus income-producing equities (dividend shares, REITs) | Regular income | Low to medium | Retirees drawing an income |
| Dividend | Preferred and common shares of dividend-paying companies | Tax-advantaged dividend income and some growth | Medium | Non-registered investors wanting Canadian dividends |
| Balanced | A mix of bonds and equities (for example 40/60 or 60/40) | Growth and income with moderate volatility | Medium | Most moderate investors; often the default |
| Equity | Canadian, US, international or global stocks | Long-term growth | Medium to high | Long horizon, higher risk tolerance |
| Real estate | Directly held properties or real estate securities | Income and inflation protection | Medium; liquidity risk for direct property | Diversification; may limit redemptions in stressed markets |
| Index | Securities that track a market index | Match an index at low cost | Same as the index | Cost-conscious investors |
| Fund of funds | Units of one or more underlying funds | Diversified, managed asset allocation in one fund | Depends on the mix | Investors wanting a one-fund portfolio |
| Specialty | One sector, region, theme or style (technology, emerging markets, resources, socially responsible) | Targeted growth | High; industry and concentration risk | Small satellite holdings only |
Two features deserve attention:
- Fund of funds: Many segregated funds invest in an underlying mutual fund (called a secondary fund) run by an investment manager. If one secondary fund makes up 50% or more of the segregated fund's assets, the Fund Facts list that secondary fund's top 10 holdings.
- Managed-volatility and portfolio funds: Insurers increasingly offer funds that actively reduce equity exposure in volatile markets. These lower the insurer's guarantee costs and the client's swings in value, at the cost of some upside. The curriculum lists managed volatility as an advantage of segregated funds for individual investors.
2. Fund Analysis
Analyzing funds means comparing what the insurer offers with what the client needs.
Current offerings. Each insurer has a fund lineup, guarantee classes and fee series. A typical contract offers:
| Guarantee class | Maturity guarantee | Death benefit guarantee | Relative cost |
|---|---|---|---|
| 75/75 | 75% | 75% | Lowest |
| 75/100 | 75% | 100% | Middle |
| 100/100 | 100% | 100% | Highest; often includes resets |
Fee series include front-end, no-load, fee-based (F-class) and advisor chargeback options. New deferred sales charge (DSC) sales ended by June 1, 2023.
Client needs vs. products. Use the Fund Facts to compare:
- the objective and risk rating (Low to High) with the client's objective and risk tolerance,
- the fund expense ratio for the guarantee class chosen,
- the performance history, remembering that past returns do not predict future returns,
- the time horizon: the maturity guarantee needs at least 10 years, so short-term goals belong in money market funds or GICs.
A client who is risk-averse but wants growth may suit a balanced fund in a 75/100 or 100/100 class; a 35-year-old with a long horizon and high risk tolerance may prefer an equity fund in the lowest-cost class, or may not need a segregated fund at all.
3. Applying Basic Tax Principles
Non-registered contracts:
- Allocations: each year the fund allocates its interest, dividends, foreign income and net realized capital gains or losses to contract holders, reported on a T3 (Relevé 16 in Quebec), even though no cash is paid out.
- Dispositions: a withdrawal, surrender or switch between funds is a disposition. The gain or loss is the proceeds minus the adjusted cost base (ACB) of the units sold.
- No withholding: Canadian residents have no tax withheld on non-registered withdrawals; the tax is settled on their return.
Registered contracts (RRSP, RRIF):
- No allocations are taxed while money stays in the plan.
- Withholding tax applies when money is withdrawn: 10%, 20% or 30% on RRSP withdrawals depending on the amount (5%, 10% or 15% federally in Quebec, plus Quebec tax), and on RRIF withdrawals above the annual minimum.
- Withdrawals by non-residents are generally subject to 25% non-resident withholding unless a tax treaty reduces it.
TFSA contracts: no tax on allocations or withdrawals.
4. Case: Matching Funds to Needs
Elena, 61, wants income in five years and is nervous after a recent market drop. She has $200,000 in a non-registered account.
- Money needed within five years: a money market or short-term bond fund, because the maturity guarantee would not apply that soon.
- Longer-term money: an income or balanced fund in a 75/100 class, so a death benefit guarantee protects her heirs from the start.
- Tax: a dividend fund in the non-registered contract would give tax-advantaged Canadian dividends; interest-heavy bond funds are better held inside her RRSP.
- Avoid: specialty funds, which add industry risk she does not need.
A segregated fund holds mainly first mortgages on residential properties. Which description fits it best?
A specialty fund with high industry risk and growth as its objective
A mortgage fund aiming for steady income with relatively low volatility
A money market fund holding securities that mature within 30 days
An index fund that tracks the real estate sector of the Canadian stock market
A segregated fund invests 80% of its assets in a single underlying mutual fund. What will its Fund Facts show under "What does the Segregated Fund invest in?"
Only the name of the underlying fund, with no holdings listed
The top 10 holdings of the underlying (secondary) fund
The insurer's own top 10 corporate investments
A complete list of every security the underlying fund owns
Nadia, a Canadian resident, withdraws $8,000 from a non-registered segregated fund contract. How is tax handled?
The insurer withholds 20% because the amount is over $5,000
The insurer withholds 30% and Nadia reports nothing on her return
No withholding; she reports any capital gain or loss on her return
The full $8,000 is taxed as interest income in the year of withdrawal
Sections you finish are checked off in the contents.