What is Segregated Funds?
Segregated funds are insurance contracts that will pay the policyholder a specific amount based on a group of similar pooled investments. A segregated fund is like an insured mutual fund that provides certain guaranteed benefits on maturity and death. Segregated funds are legally known as individual variable insurance contracts.
Who Can Purchase a Segregated Fund?
For the most part, anyone can purchase a segregated fund. Most Canadian provinces do not have specified age restrictions for the sale of segregated funds. However, since this is an insurance contract based on someone’s life, some insurance companies might place an age restriction for individuals who pose a higher risk of potential payout based on the type of benefits they are providing.
Segregated funds are purchased by the annuitant, which is usually the person the life insurance benefits are based on. It is possible for an annuitant to purchase a segregated fund for which the benefit is not based on their life but someone else, assuming the segregated contract is held outside a registered plan.
What Type of Benefits do Segregated Funds Offer?
There are four benefits that segregated funds offer to those who choose to purchase them, which include;
- Protection from creditors
- The ability to name a beneficiary when purchasing a segregated fund, means you can ensure in the event of a bankruptcy or civil claim creditors may not be able to claim against the benefits given the beneficiary would have priority.
- A death benefit guarantee
- Segregated funds will guarantee a certain amount to be paid out upon death.
- A maturity guarantees
- Segregated funds also provide a certain amount upon maturity.
- Probate passing ability
- You can name a beneficiary when you purchase segregated funds. As a result, those proceeds will go directly to the beneficiary upon death rather than being part of your estate’s assets, thereby avoiding probate.
Why buy a Segregated Fund?
The primary reason most people consider purchasing a segregated fund is for its death and maturity benefit guaranteed. Segregated funds can be guaranteed anywhere from 75%-100% of the principal amount invested over a 10-year holding period.
For example, if you invest $100,000 in a 100% maturity guaranteed segregated fund and hold it for 10 years. At the end of the 10th year, the fund’s market value is $90,000. You would get $100,000 back, which was your original principle. The minimum guarantee in most provinces is 75% over a 10-year holding period. The maturity guaranteed only kicks in if you’ve held it for a 10-year period.
Can You Withdrawal Funds Early from a Segregated Fund?
You can withdraw funds earlier than the 10-year holding period, however, the maturity guaranteed would not apply. Furthermore, the guaranteed maturity amount will be reduced by the amount withdrawn. For example, if you purchased a $100,000 segregated fund with 100% maturity guaranteed and eight years into the investment you pulled $20,000. The maturity guaranteed will be reduced by $20,000, which means the insurance company will only have to guarantee $80,000, not the initial $100,000 as you made a withdrawal against the original principle.
Are Segregated Funds Regulated?
Segregated funds are provincially regulated as they are insurance contracts. Investments are not actually held by the purchaser of the segregated fund, rather a basket of investments is managed by the insurance company on which the benefits are based.
If an insurance company is unable to meet its obligations, the investor is protected by Assuris, which is the organization that protects Canadian policyholders of insurance contracts. As of 2022, if an insurance company fails, Assuris will provide the policyholder up to $60,000 or 85%, whichever is higher than the expected benefit. You can search here to confirm if the insurance company you wish to purchase your segregated fund is an active member of Assuris.
How do you purchase Segregated Funds?
Since segregated funds are insurance contracts they can only be sold by a licensed life insurance agent. The segregated funds can only be purchased through a life insurance company.
Do You Pay Tax on Segregated Funds?
Payment guarantees received upon death or maturity are taxable. In general terms, you will pay tax on the difference between your initial capital and the capital gains plus the maturity guaranteed. I recommend you seek a tax professional for tax planning needs.
Mutual Funds vs. Segregated Funds: What’s the Difference?
Mutual funds operate by collecting various amounts of money from a group of investors that is pooled together to purchase a specific group of mutual fund investments. The mutual fund charges the investors a fee to manage the investment in accordance with the fund’s objectives and risk profile.
Segregated funds are similar to mutual funds in their structure, except there are certain guaranteed benefits it offers as it’s an insurance product. The policyholder does not own the actual pool of investment but rather has an insurance contract with the insurance that will pay them certain benefits. Here are the major difference between a segregated fund and a mutual fund;
Segregated Funds
- Provide better creditor protection
- Provide a principle guarantee
- Provide a death benefit guaranteed
- Can avoid probate
Both
- Are professionally managed
- Both charged a management expense ratio fee. Segregated fees are higher than mutual fund fees as they also included an insurance fee as part of their management expense ratio.
- Mutual funds can be sold by licensed mutual fund individuals. Segregated funds can only be sold by licensed life insurance agents.
In short, segregated funds are similar to mutual funds, but they have certain guaranteed benefits to the policyholder such as death and maturity benefit and can only be sold by licensed life insurance agents.
How Expensive are Segregated Funds?
Due to the added benefits offered by segregated funds, their management expense ratios (MER) are much more expensive when compared to mutual funds. The MER charged by the insurance company may include an insurance fee or be charged separately. This insurance fee may range anywhere from 0.75-2% in addition to the fund’s regular MER fee. As such, segregated funds can be an expensive product.
Should You Purchase a Segregated Fund?
The decision to purchase a segregated fund or not comes down to your personal and financial situation. This product can have a place in a portfolio but extra due diligence needs to be taken to ensure you understand the product being bought. One of the biggest drawbacks is the fees attached to this product in order to provide the product guarantees that it offers. Those fees could outway the benefit purchasing a segregated fund might offer.
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