We have discussed several investment vehicles available to investors such as Mutual Funds and ETFs, however lately I have been getting more and more questions about segregated funds so thought I should shed some light on this investment vehicle.
What Is A Segregated Fund?
On the surface a segregated fund is very similar to a mutual fund however there are some important differences. Segregated funds are technically insurance contracts and can only be offered through insurance companies, you are purchasing an insurance contract and you never own the underlying funds. On the technical side that is the main difference between segregated funds and mutual funds.
Guarantees on Segregated Funds
75% Guarantee
By law all segregated funds must guarantee at least 75% of your principle, so if you purchase a segregated fund worth $100,000 you are guaranteed at least $75,000 no matter what happens to the markets (yea I know what you are thinking…too late). However the guarantee only applies after 10 years, so your must be invested for 10 years before your 75% guarantee kicks on, if you decide to withdraw funds prior to 10 years you will loose the proportion of your guaranteed value. Often you can move within the fund family for example move from an aggressive Sunwise fund to a more conservative Sunwise fund as long as you stay within Sunwise. This guarantee comes with a high cost build into the MER, segregated funds often have extremely high MER fees when compared to similar class mutual funds, often in excess of 1.5% higher. Although recently these fees have come down slightly they continue to remain fairly high. The 75% is the minimum a segregated fund must provide, most companies give investors the option to increase this guarantee to 100% for an extra fee. You also have the option to reset your principle amount if your market value increases, however this restarts the 10 year lock-in cycle.
Death Benefit – Probate Protection
Since segregated funds are insurance contracts you can assign a beneficiary and making asset transition a lot smoother. Segregated funds also by pass probate fees which can save your estate thousands of dollars in probate fees. The death benefits are also guaranteed to 100% regardless of when it occurs.
Creditor Protection
If you are involved in a lawsuit and loose all or file for bankruptcy all your assets are fair game for creditors. However segregated funds enjoy creditor protection and cannot be touched by creditors.
Guaranteed Minimum Withdrawal Benefit (GMWB)
Recently segregated funds have implemented a new feature often referred to as guaranteed minimum withdrawal benefit (Manulife Income Plus, Desjardins Helios etc). This feature is designed for retirees who depend on the income from their investments. This option guarantees your fund will last for a specified time, often 20 years, no matter what happens to the markets. It also resets your value every three years if your market value has increased, this feature can be added on at later years for an extra fee. We will discuss GMWB in more detail in a future post.
Negatives
Although the idea of the guarantees and benefits seem very appealing to investors, specially after 2008, one must remember that these do not come free. Segregated fees can eat up a large chunk of your investment and often you may not see the value, the 10 year lock-in period is also a huge drawback. Rarely will investors loose out over a 10 year period.
Who is Segregated Funds For?
Although I am not a big fan of segregated funds or mutual funds, there maybe some people who would benefit from this type of fund. The primary candidates would be very conservative retirees who depend on this income; the GWB can provide them with a peace of mind and reduce their worries.
My Thoughts
I believe in keeping investing simple and avoiding unnecessary expenses, segregated fund are too expensive and the features are not worth it for most investors. Here are 10 Tips for successful investing and investing rules of thumb.
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Article by Ray
Ray is an ex-financial adviser and the founder of Financial Highway. Currently working in the financial industry and working towards completing his Chartered Financial Analyst, CFA, designation.
Ray has written 271 articles.
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{ 3 comments… read them below or add one }
Thanks for educating the general public about segregated funds. I didn’t have the slightest idea what this was minutes ago. The 75% guarantee policy is an interesting one, and the possibility that one can even increase the guarantee percentage even higher, makes segregated fund much more appealing.
There is no such thing as a ’10 year lock-in period’ and saying so gives the impression that someone would be unable to access their money. There is a 10 or 15 year maturity guarantee — meaning — regardless of how far the investments had declined after the specified time period the investor would receive the original invested amount. If the Segregated fund has increased in value the maturity guarantee is meaningless — at no time is the invest ‘Locked-in’
As far as not loosing over a 10 year period, those invested in ‘tech’ mutual funds from the late 90s, which lost in some cases 80% — have lost that money — forever! Those with Seg funds begin receiving their original investments back next spring.
The prime candidate for Seg funds are folks looking to pass on an Estate — because regardless of what the market does the 100% Death Benefit of the Seg funds bypasses the probate process completely and the money gets into the hands of the beneficiaries faster then any other way.
PS there are terrific Seg funds that have lower MERs (management expense ratios) lower than 70% of the equivalent Mutual funds. So the argument that ALL Seg funds cost more and are TOO expensive is wrong.