12.3 Segregated Funds, Labour-Sponsored Funds & Listed Private Equity

Beyond mutual funds and ETFs, Canadian investors can choose managed products with insurance features, tax incentives or access to private markets. Each has advantages and trade-offs that affect suitability.

Segregated Funds

A segregated fund is an individual variable insurance contract (IVIC) issued by a life insurance company. The contract invests in one or more underlying funds that resemble mutual funds, but the assets are held separately (segregated) from the insurer's general assets, and the contract adds insurance guarantees.

The Parties

• Contract holder: owns the contract and makes the investment decisions.
• Annuitant: the person whose life the guarantees are based on (often the same as the holder).
• Beneficiary: receives the death benefit.
• Insurer: issues the contract and provides the guarantees.

The Guarantees

Other Features

• Estate planning: with a named beneficiary, the death benefit is paid directly, bypassing the estate, probate fees and delays.
• Creditor protection: a contract with a beneficiary in the family class (spouse, child, grandchild or parent), or an irrevocable beneficiary, may be protected from the holder's creditors, which appeals to business owners and professionals.
• Protection if the insurer fails: Assuris, the industry's protection organization, guarantees that the policyholder will retain up to $100,000 or 90% of the segregated fund guarantee, whichever is higher.
• Costs: seg funds charge higher fees than comparable mutual funds because the insurer charges for the guarantees.
• Regulation: seg funds are insurance products, sold by licensed life insurance agents and regulated by provincial insurance regulators, with industry standards in the CLHIA's Guideline G2. They are not securities regulated under NI 81-102.

Taxation

In a non-registered contract, the fund allocates its income and capital gains to the contract holder each year. Unlike a mutual fund trust, a seg fund can also allocate capital losses to holders. A guarantee top-up paid at maturity or death is generally treated as a capital gain, and withdrawals or redemptions trigger gains or losses.

Worked Example: How the Guarantees Work

Lena deposits $100,000 in a segregated fund contract with a 75% maturity guarantee and a 100% death benefit guarantee. Ten years later, after a market downturn, the contract is worth $70,000.

• At maturity: she receives the higher of the market value ($70,000) and the guarantee ($100{,}000 \times 75\% = 75{,}000$), so the insurer tops up $5,000.
• If she had died instead: her beneficiary would receive the higher of $70,000 and the 100% guarantee of $100,000, a top-up of $30,000.
• With a reset: if the contract had grown to $130,000 in year 4 and she had reset it, her guarantees would be based on $130,000, usually with a new 10-year maturity date.

The guarantees matter most when markets fall near the maturity date or the annuitant's death. In a rising market, the holder pays the higher fees for protection that is never used.

Segregated Funds vs. Mutual Funds

Labour-Sponsored Venture Capital Corporations (LSVCCs)

An LSVCC is a fund sponsored by a labour organization that invests in small and medium-sized businesses, often in its home province. Governments encourage these investments with tax credits:

• A federal tax credit of 15% applies to shares of provincially registered LSVCCs on up to $5,000 of purchases a year, a maximum credit of $750. There is no federal credit for federally registered LSVCCs.
• Some provinces add their own credits, and the shares can be held in an RRSP.
• Shares must usually be held for a minimum period (often eight years), or the credits must be repaid.

Risks: LSVCCs are concentrated in small private companies, can be hard to value, are illiquid during the holding period, and often charge high fees. They suit investors who can lock up money for years and want the tax credits, and they should be only a small part of a portfolio.

Listed Private Equity

Listed private equity companies and funds are traded on a stock exchange but invest in private companies through buyouts, venture capital and growth investments. They give ordinary investors access to private equity with daily liquidity, without the high minimums and long lock-ups of private funds. Their shares can trade at a discount or premium to the estimated value of their holdings, results depend heavily on the manager, and private holdings are valued infrequently.