Segregated Funds

Do you like the feeling of knowing that your money is well invested and well protected? Segregated funds combine the growth potential of a mutual fund with the security of principal guarantees.

Mother and Daughter Relaxing on Stairs

Segregated funds have gained wider recognition in recent years and are a growing segment of the investment fund industry in Canada. Segregated funds have unique features that enable them to meet special client needs such as maturity guarantee, death benefits and creditor protection. Unlike other types of investment funds, segregated funds are insurance contracts and, therefore, mostly exempt from the requirements of provincial securities laws. A “segregated fund” is a pool of assets owned by the life insurance company. They are separate and apart from other similar pools and its general assets.

Like mutual funds, segregated funds offer the advantages of professional investment management and portfolio diversification. Another similarity is that these benefits come at a price. Management fees and expenses are deducted from fund assets and have a direct and measurable impact on fund performance.

Segregated funds alter one of the conventional principles of portfolio selection. Namely the notion that the older the client, the less exposure he or she should have to riskier long-term assets. With the availability of maturity guarantees of up to 100%, along with death benefits, the risks associated with capital markets become less of an investment constraint. Segregated funds enable clients to invest in higher-growth asset classes, while offering assurance that the principal amount of their contributions is protected, either fully or partially

Maturity and Death Guarantees

One of the fundamental contractual rights associated with segregated funds is the guarantee that the beneficiary will receive at least a partial return of the funds invested in accordance with the provisions of the contract. Provincial legislation requires that the guarantee be at least 75% after a 10-year holding period. Some sponsors of segregated funds top up the maturity guarantees to 100%. These guarantees – whether full or partial – appeal to people who want specific assurances about the return of the principal amount invested and a limit on their potential capital loss.

Example Maturity Guarantee

John deposited $150,000 in a segregated fund policy and named his son, Robert, as beneficiary. The policy offers a 100% guarantee on death or maturity with a minimum 10-year holding period. Five years later, John dies in a car accident while driving to work. If we assume that the investments within the segregated fund policy are worth $200,000 at John’s death, Robert would receive $200,000. If, however, the investments have dropped in value and are worth $110,000 at John’s death, then Robert would receive $150,000, the amount John originally deposited.

The maturity date of a segregated fund contract is an important date. It is normally set 10 years from the contract date and, by law, it cannot be less than 10 years. The maturity date is a critical component of the contract because the maturity guarantee comes into effect on that date, and no sooner. So, if an investor decides to redeem a segregated fund contract, say 8 years from the contract date, the investor would be paid the market value of the segregated fund holdings, whatever the market value may be on the date of redemption. The maturity guarantee would not get triggered until the maturity date.

Do you really need a guarantee?

In historical terms, the risk of losing money in the North American stock markets over a minimum 10-year holding period has been virtually non-existent. The rarity of negative 10-year returns has led many advisors and experts to conclude that the costs of full (i.e., 100%) maturity guarantees exert an unwarranted drag on a client’s investment returns.

But the potential value of maturity guarantees should not to be dismissed outright. As the performance of the Japanese market suggests, even the largest and most developed markets are vulnerable to capital loss over a 10-year (or longer) period. The Nikkei (Japan’s most widely watched index of stock market activity) peaked in December 1989 at 38,915 and was only in the 14,180 range in February 2014, nearly 25 years later.


Bypass Probate Fees

When you designate a beneficiary other than your estate, the value of your segregated fund policy flows directly to him or her, generally bypassing the estate and potential probate fees. Upon death, proceeds of your contract are paid directly to your beneficiary, avoiding the time and expense of probate. Probate is a legal proceeding whereby the Will of a deceased person is validated by the courts. The fees vary from province to province and in most cases these fees are based on a percentage of the value of the estate.

Also, probate is a public process and information associated with it is accessible to the public. By helping your heirs bypass probate, segregated funds can ensure that your personal decisions and information remain the way they were meant to be…personal.

This feature is quite beneficial. As you can see by the following example, the amount of money saved can be quite significant.

Potential Creditor Protection

This feature is of primary concern for business owners or professionals as their assets may be exposed to creditors. You may be able to achieve potential creditor protection by naming a “preferred” or “irrevocable” beneficiary. The key relationship is between the life insured (the annuitant) and the beneficiary. There are exceptions to this and it is recommended that you consult independent legal counsel.

The Downside

Segregated funds offer a host of features and benefits, but those amenities are not free. The cost of investing in segregated funds is often higher than the cost of investing in similar mutual funds.

The Best of All Worlds

Segregated funds offer a unique investment option for investors seeking to participate in the financial markets. They provide an opportunity to benefit from the upside potential, but protect from the possibility of losing money. The peace of mind provided by insurance protection might be worth the price of admission.

Put the benefits of segregated fund policies to work for you. Segregated funds, are a powerful investment solution that can help you meet your retirement goals. While similar to mutual funds, they offer many unique advantages— including maturity and death benefit guarantees, the ability to bypass estate probate, potential creditor protection and the ability to reset any market gains.

Contact Claudio

Claudio Piron CPA, CA, CFP®, CSWP, TEP
Senior Investment funds Advisor
Insurance Advisor

HollisWealth Insurance Agency Ltd.
4 Director Court, Suite 110
Vaughn, Ontario, L4l 3Z5
Phone: 905 712 9302
Fax: 905 712 9330

Mutual Fund Dealers Association of Canada