On the surface, segregated funds (or seg funds as they are more commonly called) look and act like a mutual fund.

To the untrained eye, the differences between seg funds and typical mutual funds are almost invisible. But don’t be fooled. Differences do exist, and have a significant impact on how seg funds are treated for tax purposes.

A seg fund is deemed by the Income Tax Act to be a trust for tax purposes. When an investor purchases a seg fund, the cash is used by the seg fund trust to purchase its investments, which may include units of a mutual fund. As a result, an investor in seg funds does not own the seg fund’s investments. Rather, it’s the seg fund trust that owns the investments.

The investor is a contract holder and the contract is an annuity contract governed by provincial insurance law.

One of the greatest selling features of seg funds is the capital guarantee offered. Investors can sleep well at night with the assurance that their capital is protected and will be returned to them after 10 years (maturity guarantee) or on death (death guarantee) – whichever comes first. This is true regardless of any drop in value that the seg fund’s investments might have suffered.

Different seg fund companies offer different capital guarantees. The tax impact of receiving a “top-up” as a result of a capital guarantee can be complex.