Canadian Investment Services: Segregated Funds
A Mutual fund with added benefits
Since the early 60’s, Canadian life insurance companies have been offering segregated "seg" funds, the insurance industry’s version of mutual funds. As interest rates increased over the years, especially in the 80’s, segregated funds have been offered as an alternative, so that insurance companies could still compete on the market, since many individuals would rather take their chances on the market, than buy insurance policies. There has been a large increase in popularity since the mid 90’s as investors search for investment vehicles providing a combination of better returns and capital guarantees.
The name seg fund is easier to remember than the true name of these investments: individual variable insurance contract.
The "seg" name derives from the fact that the assets in these funds are held separately from the insurer’s own assets, hence "segregated".
What is a Segregated Fund?
- a mutual fund with a couple of extra’s (i.e. death benefit, creditor protection, estate planning benefits, reset feature)
Maturity and Death Benefit
-
must offer a minimum 75% guarantee of the initial investment, some companies offer 100% guarantee of principal
-
the principal is guaranteed at the maturity of the contract, the end of 10 years.
ex. Jan. 1st 2002, you purchase $10,000 in Canadian Balanced Growth providing you with 1000 units in the fund, on Jan. 1st 2012 the contract matures, you shall receive the market value of your units or the amount guaranteed, which ever is higher. If you units were valued at &18 each then your book value is now worth $18,000, not $10,000.
If the policy holder dies before the maturity date then the guaranteed value will be paid to the beneficiaries. The death benefit may differ, some companies guarantee 75% of the initial investment at death, while others will guarantee 100% of the initial investment. There are companies that provide the 100% death benefit only until age 90, and then a lower percentage after that age.
Additionally the maturity benefit and the death benefit may differ as follows:
| Maturity |
Death |
| 75% |
75% |
| 75% |
100% |
| 100% |
100% |
Guarantees
- There are 2 types of guarantees, contract–based or deposit based.
Contract–based
- all deposits made into the fund up to the 10–year maturity are guaranteed
Deposit–based
- all subsequent deposits will have their own 10–year maturity date.
Creditor Protection
- Since seg funds are insurance products, they can offer creditor protection provided a preferred beneficiary has been named under the contract, being a spouse, child, grandchild or parent.
Estate Planning Advantages
- Similar to life insurance proceeds, a named beneficiary in the seg fund contract will receive the funds directly, eliminating delays and costs often associated with probate.
- Provides another degree of privacy in the estate distribution process, since the beneficiary need not be named in the will.
Taxation
- There are important tax differences in how seg and mutual funds allocate capital gains and losses.
- A mutual fund investor purchasing at year–end may face a capital gains distribution on the net realized gains that have accumulated in the fund during the entire year. A segregated fund, however, allocates income on a time–weighted basis. The investor will receive an amount proportionate to the time that they were actually invested in the fund.
- Mutual funds can distribute only capital gains, losses in a mutual fund can only be claimed upon redemption. Whereas seg funds can also allocate capital losses, so the holders of non–registered seg funds can claim capital losses against capital gains from other investments, without having to sell their units.
- Registered seg funds are tax deferred, non–registered seg funds are also tax deferred.
- Upon death of the policyholder, the full amount including the capital gains is paid 100% to the beneficiary tax free.
Reset Feature
- allows investors to lock in market growth.
- most companies limit policyholders to a maximum of 2 resets per year.
ex. You purchase $10,000.00 in the Moderate Growth Fund, providing you with 1000 units at $10.00 a unit. 3 months later, the unit price is $11.00, resulting in a new market value of $11,000.00. If you choose to reset your investment, the minimum benefit guaranteed is now $11,000.00 not $10,000.00. When a reset is called, the 10 year term is also reset.
Important to note
Withdrawals
- policyholders are allowed to withdraw 10% of the total value of their funds each year, service charge free without triggering any change to the maturity period.
Fee Schedule
- any withdrawals exceeding the 10% maximum per year is subject to the following fee schedule
| 1st year |
– |
6% |
| 2nd year |
– |
5% |
| 3rd year |
– |
4% |
| 4th year |
– |
3% |
| 5th year |
– |
2% |
| 6th year |
– |
1% |
| 7th year |
– |
0% |
| 8th year |
– |
0% |
| 9th year |
– |
0% |
| 10th year |
– |
0% |
Management Expense Ratio (MER)
- MER’s for seg funds are usually 0.5% to 1% higher than those of Mutual funds, think of it as insurance for your investments.
Some companies start with a 6% service charge, others start with a 5% service charge
How Segregated Funds stack up against Mutual Funds
| |
Segregated |
Mutual |
| |
Funds |
Funds |
| Professional Money Managers |
 |
|
| Wide Variety of Funds |
|
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| RRSP Eligible |
|
|
| Potential for Unlimited Growth |
|
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| Reset Feature – Lock in Growth |
|
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| Deposit Maturity Guarantee |
|
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| Death Benefit Guarantee |
|
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| Estate Planning Benefits |
|
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| Potential Creditor Protection |
|
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| High Service Charges |
|
DSC only |
| Higher MER’s |
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