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 of the contracts 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 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 welcome but don’t forget that this deposit is reported as a capital gain. However, there’s a strategy that could help you reduce or eliminate 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, 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 result will be a tax liability. For these contracts, there’s a strategy that may allow you to eliminate or reduce the amount of tax payable.
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.
It’s important to understand 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 contract’s market value is greater than the ACB, a capital gain will be realized. However, if its market value is less than the ACB, you’ll realize a capital loss. This information may change your plans.
Described below are 3 examples that illustrate the tax implications of the maturity guarantee and potential tax savings by switching funds, where applicable. All 3 examples assume Jason opens a segregated fund contract on March 1, 2015 and deposits $100,000 into Fund A with a 100%, 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, 2025, the market value has dropped to $80,000 and Jason 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, 2015 |
Deposit |
100,000 |
100,000 |
100,000 |
March 1, 2025 |
Maturity date |
80,000 |
100,000 |
100,000 |
March 1, 2025 |
|
100,000 |
100,000 |
120,000 |
March 1, 2025 |
|
|
|
|
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. 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, 2015 |
Deposit |
100,000 |
100,000 |
100,000 |
March 1, 2025 |
Maturity date |
80,000 |
100,000 |
100,000 |
March 1, 2025 |
|
100,000 |
100,000 |
120,000 |
March 1, 2025 |
|
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, 2015 |
Deposit |
100,000 |
100,000 |
100,000 |
March 1, 2025 |
Maturity date |
125,000 |
140,000 |
100,000 |
March 1, 2025 |
|
140,000 |
140,000 |
115,000 |
March 1, 2025 |
|
140,000 |
140,000 |
140,000 |
Ideal candidates
Investors:
- who'll 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.
Investment options—Manulife segregated fund contracts
Manulife and its subsidiaries provide a range of investments and services including Manulife segregated fund contracts that combine 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 contract (i.e., a registered retirement savings plan or registered retirement income fund) isn’t taxable when deposited into the contract, but any withdrawals are fully taxable. Withdrawals from tax-free savings accounts are tax free.
Important disclosure
Any amount that is allocated to a segregated fund is invested at the risk of the contract holder and may increase or decrease in value.
This communication is published by Manulife Investment Management. Any commentaries and information contained in this communication are provided as a general source of information only and should not be considered personal investment, tax, accounting or legal advice and should not be relied upon in that regard. Professional advisors should be consulted prior to acting based on the information contained in this communication to ensure that any action taken with respect to this information is appropriate to their specific situation. Facts and data provided by Manulife Investment Management and other sources are believed to be reliable as at the date of publication.
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