Segregated Funds
Segregated funds (often called "seg funds") are unique investment products in Canada that combine the growth potential of investment funds with features of an insurance contract. In essence, a segregated fund is similar to a mutual fund in that your money is invested in a diversified portfolio of stocks, bonds, or other assets managed by professionals. However, segregated funds are offered by insurance companies and come with insurance guarantees on your capital, as well as other benefits like creditor protection and estate planning advantages.
How Segregated Funds Work
A segregated fund is an individual variable insurance contract. When you invest, you are purchasing an insurance contract from a life insurance company, and the contract's value is tied to an underlying investment fund (often one managed by the insurer or a partner asset manager).
The underlying investments can range widely – there are seg funds that mirror stock indexes, balanced funds, fixed-income funds, and even specialty mandates. The key difference is the insurance contract's provisions.
Canadian regulations require segregated funds to offer:
● Maturity guarantee (usually at least 75% of the amount you invest, after a minimum holding period like 10 years)
● Death benefit guarantee (often 100% of your invested principal, minus withdrawals)
These guarantees mean that if markets drop significantly, the insurance company will cover any shortfall to bring your payout up to the guaranteed amount.
For example, if you invested $100,000 in a seg fund with a 100% death benefit guarantee and the market value falls to $80,000 at your passing, the insurance company would top it up and your beneficiary would still receive $100,000.
Segregated funds also typically allow for "resets" – at certain intervals, you can lock in gains by resetting the guaranteed amount to the current higher market value. This feature means if the market does well, you can increase the floor that's protected.
Benefits of Segregated Funds
Capital Guarantees and Risk Reduction
The foremost benefit is the protection of capital. This makes segregated funds a popular choice for people close to retirement or already retired who cannot afford large market losses on their nest egg.
During times of market turbulence, seg fund investors have the reassurance that a floor is in place.
Estate Planning Advantages
Segregated funds offer distinct estate planning and beneficiary advantages because they are insurance contracts. You can name a beneficiary on a segregated fund, just like on a life insurance policy.
Upon death, the seg fund proceeds bypass the estate and go directly to the named beneficiaries. They do not require probate. This can save time and probate fees, and maintain privacy.
Potential Creditor Protection
During your lifetime, properly structured segregated fund contracts with certain family-class beneficiaries might be exempt from seizure.
This is relevant for entrepreneurs or professionals. If you declare bankruptcy or have creditors pursuing you, your investments may be protected.
Reset and Income Features
Many modern seg funds come with additional features like the ability to reset your guarantees and sometimes guaranteed withdrawal benefits for retirement income.
Some segregated fund contracts offer a Guaranteed Lifetime Withdrawal Benefit (GLWB), which ensures you can withdraw a certain percentage annually for life, regardless of market performance.
Who Should Consider Segregated Funds?
Individuals Nearing Retirement
If preserving capital is paramount and you want to ensure a legacy for your heirs, seg funds can guarantee that your investment will be intact when needed.
If you don't have a large defined-benefit pension, products with lifetime withdrawal guarantees can form a personal pension.
Business Owners and Professionals
Those who desire creditor protection or have estate complexity can benefit. For example, a business owner might invest surplus personal funds in a seg fund naming their spouse as beneficiary.
This could safeguard that money from potential business creditors and provide for the family if something happens.
Conservative Investors
Even younger investors who are very risk-averse might use seg funds because the guarantees give them the confidence to stay invested in equities.
If someone might otherwise sit in cash or GICs out of fear, a seg fund could be a bridge to earning higher returns with a backstop in place.
Estate Planners
If you have a specific bequest in mind (e.g., you want to leave $50,000 to a grandchild or a charity), a seg fund can ensure that amount is preserved and delivered directly.
It's akin to a life insurance policy, but with the chance to grow that money in the meantime.
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