How are capital gains and interest income earned within a segregated fund treated for tax purposes in a non-registered account?

Question: How are capital gains and interest income earned within a segregated fund treated for tax purposes in a non-registered account?

Answer options:

• They are only taxed when the policy is cashed in (surrendered). ✅ They are taxed in the year they are allocated to the contract holder.
• They are tax-free because segregated funds are treated like life insurance.
• They are taxed as a flat 15% rate regardless of the holder's income bracket.

Correct answer: They are taxed in the year they are allocated to the contract holder.

Explanation: When a segregated fund is held in a non-registered account, the insurer 'allocates' the fund's income (interest, dividends, capital gains) to the contract holder annually. The contract holder must report this income on their tax return even if they didn't withdraw the money. These allocations increase the ACB of the units held, preventing double taxation upon eventual sale.