So, what are segregated funds? Segregated funds are investment funds that have maturity and death benefit guarantees associated with them.
Think of them as “mutual funds with an insurance wrapper”
Segregated funds are offered by insurance companies, and are insurance products. Meaning that they can be sold by insurance agents in Canada. Whereas advisors that offer traditional mutual funds or securities have separate licensing requirements in Canada.
How are segregated funds different than mutual funds?
Segregated funds have a number of features that traditional mutual funds do not have.
But these features don’t come without cost. Segregated funds usually have management expense ratios (MERs) that are higher than a typical mutual fund, and they are much higher than an index ETF. Meaning that for the average long-term investor segregated funds are not suitable products.
What are the Guarantees that Segregated Funds Provide?
Segregated funds provide two guarantees. A principal guarantee (aka maturity guarantee) and a death benefit guarantee.
When people speak about segregated funds you may hear them saying things like
- 75 / 100
- 100 / 100
In the case of a 75 / 100 segregated fund, the principal guarantee refers to the first number “75” in the “75 / 100” quotation.
The death benefit guarantee refers to the second number, “100” in the “75 / 100” quotation.
Principal Guarantee
The principal guarantee is also called a “maturity guarantee”.
A 75 / 100 segregated fund has a 75% principal guarantee. So if you invested $100,000 into a segregated fund and the value decreased to $70,000 at the segregated fund maturity date you would receive $75,000.
However, this principal guarantee is only provided if the segregated fund is held to its maturity date, which is typically many years. If you purchase a segregated fund and sell it shortly after you will likely not receive the benefits of the principal guarantee.
Death Benefit Guarantee
The death benefit guarantee is paid out when the owner of the segregated fund dies.
Most segregated funds offer 100% principal protection on death, so there is no risk of principal when the investment is being made. That doesn’t automatically make it a good investment, but it does provide some peace of mind.
This means if you invested $100,000 into a segregated fund your beneficiaries will receive at least $100,000 back when you pass away. But the likely scenario is if you hold the segregated fund for a long enough period the value will exceed $100,000 and you would end up receiving the market value of your funds instead.
How do you know if you are invested in a Mutual Fund or a Segregated Fund?
There are two ways to know which type of investment fund you have.
- The licensing of the advisor who provided the funds to you
- The fund company associated with the products you purchased
Firm Licensing
In Canada, most financial advisory firms are licensed as
- Investment Dealers
- Mutual Fund Dealers
You can look up a financial firm’s registration on the Canadian Securities Administrator’s website
If your advisor’s firm is not licensed under either of these categories they may not be able to provide traditional mutual funds.
Company Name
There are countless financial firms in Canada offering different products and operating under different jurisdictions. A simple rule of thumb would be to understand the company associated with the product you’re purchasing.
If the product you’re purchasing is from a life insurance company such as SunLife, Manulife or Canada Life it’s more likely that the advisor you’re working with will be investing you into a segregated fund.
If the product you’re purchasing is from a mutual fund company such as Fidelity, Mackenzie or CI Financial it’s more likely that you are buying a traditional mutual fund.
It is a bit trickier with the banks because most financial institutions stay in their lane to some degree. Either doing investments or insurance, but the banks have all of these services.
If you’re working with a bank advisor you should ask whether you’re investing in a mutual fund or a segregated fund.
Should I use segregated funds to invest?
For long term investment segregated funds are not the best way to invest.
This is because the principal and death benefit guarantees provided on segregated funds is not free. Insurance companies that offer segregated cost add the cost of these guarantees to the fund’s MER (management expense ratio).
Ultimately these added costs reduce the investment return that you receive as the investor – and if you’ve got a long investment time horizon these costs can be significant.
When should segregated funds be used?
The main benefits that segregated funds offer compared to regular mutual funds is
- Named Beneficiaries
- Creditor Protection
Named Beneficiaries
On non-registered investment accounts you cannot name beneficiaries. Meaning that the value of your non-registered accounts will be subject to probate.
To avoid the probate fee you can transfer the funds in your non-registered account into a segregated fund and when you pass the funds will be passed directly to the beneficiaries without probate fees.
Creditor Protection
Money invested in segregated funds cannot be accessed by creditors in the case of a default or bankruptcy.
However, right before bankruptcy you cannot simply transfer funds to a segregated fund and expect to avoid repurcussions. There are rules with respect to when the funds can be moved. Typically the general rule is that the funds must have been put into the segregated fund before the breakdown in credit began. But this is a question for a bankrupcty lawyer.