Taxation of Segregated Fund Contracts
Taxation of segregated fund contracts depends on registration. In a non-registered contract, income is generally taxed annually to the contract holder on an accrual basis, similar to mutual funds: interest, dividends, and capital gains are allocated and reported even if not withdrawn. Redemptions trigger capital gains or losses based on adjusted cost base (ACB). Registered contracts (RRSP, RRIF, TFSA) shelter current income, but withdrawals from registered plans are taxed as income, and RRIF minimums apply. At death, registered contracts are generally fully taxable, while non-registered contracts may trigger capital gains and accrued income on the final return. The death benefit guarantee top-up may have tax treatment that depends on the contract; do not assume all proceeds are tax-free.
Traps: seg funds are not tax-deferred in non-registered accounts. A guarantee payment is not automatically tax-free. Capital losses may be restricted. Withdrawals from registered contracts are not capital gains.
Rule of thumb: track ACB carefully and separate tax from guarantee value. Example: client invests $10,000 in a non-registered seg fund, ACB $10,000. They redeem at $12,000. The $2,000 capital gain has a 50% inclusion rate, so $1,000 is taxable, subject to the client’s marginal rate.