Segregated Funds: The Best kept Secret in the Investment Industry
Why are advisors so Quiet about Segregated Funds?
Is it that they are a unique to Canada Product that only can be sold by Financial Advisors with a Life Insurance License? Possibly
Segregated Funds are often treated as an “afterthought” or a “niche investment vehicle”, but I don’t understand this. Segregated funds are an unbelievable investment product that accomplish financial solutions that are unmatched by any other product.
Don’t believe me? Then read on!
First of all, lets discuss one important fact:
Segregated funds MUST be kept separate (segregated) from the issuer’s assets!
No one talks about this, but it is a big deal. At a time when banks are facing financial pressure and even defaulting this can present risk for some of the investment products that are intertwined within the rest of the client assets. When investing in stocks, bonds, or mutual funds in Canada you have a limit of $1,000,000 per type of accounts combined as defined by Canadian Investor Protection Fund (Please refer to their website for more specific limitations) About CIPF Coverage.
However, Segregated funds assets are kept separate. That is even in the highly unlikely event that an insurance company defaults the segregated funds are just reallocated to another Insurance Company with the assistance of Assuris. This process also includes at least 90% of the maturity and death benefit guarantees on the contract! Assuris » Guarantees on Segregated Funds
Now lets read about some of the tangible benefits:
Potential Creditor Protection
Segregated funds can protect against Seizure by creditors of your investments. This is extremely unique as an investment product. This is an INCREDIBLE benefit for business owners. Especially ones who carry debt on their balance sheet that may included personal guarantees. Why would any business owner want to put their personal investments AT RISK? It makes no sense when these products exist and allow you to invest in the market while significantly reducing exposure to seizure due to default risk of your business. There are some conditions to this benefit, so it is important to discuss this with a licensed advisor.
Maturity and Death Benefit Guarantees
Its 2008 all over again and your spouse passes away suddenly. He had a combination of stocks, bonds and mutual funds in an RSP which are down an average of 40% in less than 6 months. The money then transfers over as a Spousal Rollover and not only are you struggling with the loss of a partner, but now struggling financially due to significant market losses.
But then you realize you invested with a licensed insurance agent into segregated funds and your spouse had a 100% death benefit guarantee. This means that the funds would be topped back up by the insurance company to 100% of the Guaranteed value (adjusted for withdrawals).
Segregated fund guarantees typically come with 3 options:
75% maturity guarantee and 75% death benefit guarantee
75% maturity guarantee and 100% death benefit guarantee
100% maturity guarantee and 100% death benefit guarantee
The higher the guarantee you choose the higher the cost of that guarantee which is added to the Management Expense Ratio.
Potential to Avoid your Estate and Probate
This is a massive advantage that you can’t get with other investments particularly in a non-registered account. If you have ever dealt with an estate as a beneficiary or an executor, you may have seen just how long it can take to settle funds and the added cost of probate. This unnecessary pain can be avoided if the funds are invested in Segregated funds instead. With a Segregated Fund Contract you can name beneficiaries and it is treated like life Insurance when the owner dies. The funds are paid out to the beneficiaries very quickly and it can avoid the estate and probate by going directly to them.
There is also an important benefit of segregated funds that is often overlooked. Estates are public domain since they are legal processes. This means that anyone can find out who received the funds and may causes issues due to lack of privacy. Segregated funds are paid out privately and there are no public records.
Reset Option
Some Segregated Fund contracts also include annual reset options. This means that as the market rises you can reset your maturity and/or death benefit guarantees to the new higher values. Not all contracts include this feature, so it is important to discuss this with your advisor.
We know that Business Owners and Individuals concerned with Estate Planning can benefit greatly from using segregated funds. This is a no brainer.
But why would the young investor want to consider this as an investment strategy?
When you have the maturity and reset guarantees it can provide a lot of confidence to take additional risk with your portfolio. You know those values are protected so you may consider a more aggressive investment approach. Since segregated funds can provide excellent diversified exposure to many strong performing stocks and bonds this is an excellent opportunity to participate in capital markets in a way that may have felt too risky before.
Let’s address one final topic, shall we? The elephant in the room that critics always use as their ONE reason why they think you should avoid segregated funds:
The high fees!
Well, this may be true that for some funds they can be expensive. Some funds can have an over 3% annual management cost. Many funds however can be well in line with mutual funds and certain index funds have an annual management cost under 2%. This even includes the cost of the guarantees. It is important you have an advisor who knows your goals and is knowledgeable in these products to find you the best value possible.
*Disclosure
This article has not been reviewed for accuracy. It may contain errors. Also, there may be exceptions to some of the features described. Some estate and tax laws may vary from province to province.