Making the most of your maturity guarantee

Tax Managed Strategy 19

Many individuals have segregated fund contracts that are approaching their maturity date. If the market value has declined, you may be entitled to a maturity top-up.1 What are the implications of this and what can be done to minimize the taxes?

One of the benefits of owning segregated fund contracts is that they offer a maturity guarantee. On the maturity date, if the market value of your segregated fund is less than your maturity guarantee, you’ll receive a deposit — otherwise known as a top-up.

Receiving a top-up to your investment is definitely welcome but don’t forget that this deposit is reported as a capital gain. However, there’s a strategy available that could help you reduce or eliminate the tax on the top-up.

An in-depth look at the issue ... and the opportunities

Depending on the terms of your contract, the contract may continue after the maturity date, may come to an end with the value paid out to you, or have some other default maturity provision such as the purchase of a non-commutable life annuity. It’s important to confirm your options at maturity with your issuer and choose the option that’s best for you.

If the segregated fund contract isn’t redeemed and allowed to continue, the end result will be a tax liability. For these contracts, there’s a strategy that may allow you to eliminate or reduce the payment of taxes.

If you’re in a position to receive a top-up payment, you should consider a fund switch. By switching funds, a capital loss may be triggered to offset part or all of the capital gain that’s reported by the maturity top-up. Note that a complete offset of the capital gain will arise if the adjusted cost base (ACB) of your investment is at least equal to the maturity guarantee value.

Know the tax implications of a fund switch before proceeding. To calculate the tax, you’ll need to know your ACB of that particular fund. If the market value is greater than the ACB, a capital gain will be realized. However, if the market value is less than the ACB, you’ll realize a capital loss. This information may change your plans.

Described below are three examples to illustrate the tax implications of the maturity guarantee and potential tax savings by switching funds, where applicable. All three examples assume that Jason opens a segregated fund contract on March 1, 2010 and deposits $100,000 into Fund A with a 100 per cent, 10-year maturity guarantee.

Tip

Be aware that your segregated fund contract may have default provisions at maturity, including the possibility of conversion to a non-commutable life annuity. Find out what your maturity options are and make sure that you select your preferred option before the default provisions apply.

Example 1 – Contract ends at maturity

At maturity, on March 1, 2020, the market value has dropped to $80,000 and the contract receives a maturity top-up of $20,000. This will be reported to Jason as a capital gain. Similar to the death benefit guarantee, the contract comes to an end and the market value, including the top-up, is paid out. Any loss in the market will be realized and reported on the tax slip. In this example, the capital loss triggered on the payment to Jason is $20,000 ($100,000 market value less the $120,000 ACB).

Date

Transaction/event

Market value ($)

Maturity guarantee ($)

Adjusted cost base ($)

March 1, 2010

Deposit

100,000

100,000

100,000

March 1, 2020

Maturity date

80,000

100,000

100,000

March 1, 2020

  • $20,000 top-up
  • Reported as a capital gain

100,000

100,000

120,000

March 1, 2020

  • Contract ends
  • Payout of $100,000
  • Triggers $20,000 capital loss
     

Example 2 – Contract continues after maturity

At maturity, the $20,000 top-up will be reported to Jason as a capital gain. However, the offsetting loss in the market won’t automatically be realized because the contract will continue. But by switching the entire amount of Fund A into Fund B, Jason could realize a corresponding capital loss of $20,000, which will offset the capital gain from the top-up.

Date

Transaction/event

Market value ($)

Maturity guarantee ($)

Adjusted cost base ($)

March 1, 2010

Deposit

100,000

100,000

100,000

March 1, 2020

Maturity date

80,000

100,000

100,000

March 1, 2020

  • $20,000 top-up
  • Reported as a capital gain

100,000

100,000

120,000

March 1, 2020

  • Fund switch
  • Triggers $20,000 capital loss

100,000

100,000

100,000

Example 3 – Maturity guarantee exceeds original deposit and contract continues

The market value of Jason’s segregated fund contract on the maturity date is $125,000, but because of resets the maturity guarantee is $140,000. The contract will receive a $15,000 top-up, which is reported as a capital gain. However, Jason wouldn’t want to initiate a fund switch here as it would trigger an additional capital gain of $25,000 ($140,000 market value less the $115,000 ACB).

Date

Transaction/event

Market value ($)

Maturity guarantee ($)

Adjusted cost base ($)

March 1, 2010

Deposit

100,000

100,000

100,000

March 1, 2020

Maturity date

125,000

140,000

100,000

March 1, 2020

  • $15,000 top-up
  • Reported as a capital gain

140,000

140,000

115,000

March 1, 2020

  • Fund switch
  • Triggers $25,000 capital gain — beware

140,000

140,000

140,000

Ideal Candidates

Investors:

  • who will be receiving a segregated fund contract maturity guarantee top-up
  • whose segregated fund contract will continue after maturity

Take Action

  • Confirm what will happen to your segregated fund contract at maturity. Will it be redeemed, or will it continue?
  • Determine the applicable ACB.
  • Initiate a fund switch, if appropriate.Initiate a fund switch, if appropriate

Investment options — Manulife segregated fund contracts

Manulife and its subsidiaries provide a range of investments and services including Manulife’s segregated fund contract that combines the growth potential offered by a broad range of investment funds with the unique wealth protection features of an insurance contract. Through a Manulife segregated fund contract, investors can help minimize their exposure to risk through income, death, and maturity guarantees; potential creditor protection features; and estate planning benefits — all from a single product or insurance contract.

1 This applies to a non-registered segregated fund contract. A top-up to a registered (i.e., a registered retirement savings plan or registered retirement income fund) contract isn’t taxable when deposited into the contract, but any withdrawals are fully taxable. Withdrawals from tax-free savings accounts are tax free.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. The Manufacturers Life Insurance Company is the issuer of the Manulife segregated fund contract and is the guarantor of any guarantee provisions therein. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

MK2252E 11/20

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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