Segregated Funds

Guaranteed investment funds also known as segregated funds are offered by insurance companies. They offer professional money management like mutual funds except the investor is guaranteed a minimum of 75% or 100% of their principal on maturity or death. The majority of segregated funds offered by insurance companies with 100% guarantees on principal are after 15 years. Older segregated fund contracts offered 10 year guarantees on principal. Segregated funds are also available with a guaranteed withdrawal benefits. For investors with a long term time horizon that would like to invest in equities without risking their principal this is one of the few investment alternatives to a GICs, term deposits and government bonds. Segregated funds are also offered by mutual fund companies.

There are many additional benefits to segregated funds for investors not available in any other investment vehicle in Canada. Some of these benefits are included without any additional cost to the investor.

Additional Benefits:

1. No Estate Administration Tax (formerly known as Probate);

2. Potential Creditor Protection Ideal for business owners and self-employed;

3. Death Benefit Guarantee 100% or 75%;

4. Maturity Guarantee 100% or 75%;

5. Resets of Death Benefit Guarantee;

6. Resets of Maturity Benefit Guarantee;

7. Alternative asset classes not available in Mutual Funds;

8. Taxation;

9. Privacy;

10. Available for all Plans RRSP, RRIF, LIRA, LRIF, Tax Free Saving Account (TFSA), Non Registered Accounts and Corporate Accounts;

11. Deposits Protected by Assuris;

12. Liquidity Easily Bought and Sold like Mutual Funds;

13. A beneficiary is appointed for all account types;

14. Can be used for leveraged accounts (investment loans);

15. Guaranteed Income for Life This option is unique to segregated funds;

16. Access to institutional money managers only available to large pension plans and high net worth clients;

Estate Administration Tax (formerly known as Probate)

In Ontario estate administration tax is $5.00 dollars per $1,000 on the first $50,000 and $15.00 dollars per $1,000 thereafter. There is no cap on estate administration tax in Ontario. On a $250,000 investment estate administration tax would be $3,250.00. There is also the cost of probating a will which can run in the thousands of dollars. With a segregated fund these expenses and delays are avoided when you designate a beneficiary within the prescribed class in the contract.

Potential Creditor Protection

This valuable benefit is ideal for business owners and the self-employed. In order for a segregated fund to have creditor protection there has to be a beneficiary named in the contract within the prescribed class, this can be your spouse, child or parent. The contract has to be registered in client name, it cannot be held inside a self-directed plan or nominee account. Potential creditor protection is available to all investors. It is the most effective ways to protect savings from creditors. 

Death Benefit Guarantee

The death benefit guarantee is either a 75% or 100% in a segregated fund contract. All segregated fund have a minimum of 75% death benefit guarantees in their contracts. The guarantee is on the dollar amount invested or the last reset of the guarantee. In the event the assets are worth less than the guaranteed amount, the insurance company will pay the difference of the shortfall as a death benefit. 

In many segregated fund contracts the death benefit guarantee is reset. A reset resets the value of the guaranteed amount in the contract. If the value of the investment has increased the gains are locked in. The death benefit guarantee resets differ by each insurance company. The most common interval of the reset is on the maturity date, annually or at a specified interval such as every three years. Death benefit resets often have an age limits, the most common is up to age 75 or 80. Once they are locked in they can never decrease. 

In a segregated fund contract the death benefit is the market value of the investments at time of death or the guaranteed amount. The amount paid out is whichever is higher. If the investments are worth more than the guaranteed amount, the amount paid out is the market value of the investments at time of death. If the investments are worth less, then the amount paid out is the death benefit guarantee in the contract. 

Maturity Benefit Guarantee

A maturity benefit guarantee is either 75% or 100% in a segregated fund contract. The majority of segregated fund contracts have a minimum of 75% maturity benefit guarantee. The guarantee is on the dollar amount invested in the segregated fund contract or the last reset of the guarantee. In the event the assets are worth less than the guaranteed amount, the insurance company will pay the difference of the shortfall as a maturity benefit. Maturity benefit guarantees offered by insurance companies are 15 years, age 65 or age 100, the shorter the interval the higher the cost to provide this benefit. 

In many segregated fund contracts the maturity guarantee is reset. A reset resets the value of the guaranteed amount in the contract. If the value of the investments has increased the gains are locked in. Once a reset takes place the contract starts a new maturity guarantee period. This benefit allows the investor to automatically take advantage of profit taking without having to sell their investments. It allows the investor to maximize tax deferral by locking in gains without having to sell their investments that would trigger capital gains tax, commissions, trading fees or transaction fees. The shorted the interval for the reset in the contract the higher the cost to provide this valuable benefit.

Alternative Asset Classes not Available in Mutual Funds

Insurance companies are the dominant providers and administrators of pension plans in Canada. In order to cater to these sophisticated clients they need to offer a diversified offering of asset classes.

Taxation

When investing in mutual funds the investor is liable for the entire year of capital gains and distributions regardless of when the investment was made throughout the year in non-registered accounts. In segregated funds the only taxation that the investor is liable for is their returns in non-registered accounts. Taxation in segregated funds is based on one’s personal returns in non-registered accounts. With mutual funds you are assessed for all income earned in the period even if you didn’t benefit. In mutual fund non-registered accounts capital losses are carried forward by the fund, capital gains are taxed. In registered accounts types such as RRSP's, Spousal RRSP's, RRIF's, LRIF's, LIRA and TFSA there is no reporting of capital losses or capital gains. 

Privacy

Privacy is preserved because segregated fund contracts are not public documents. Public documents are assets distributed through a will such as a mutual fund, real estate or brokerage account. A segregated fund contract is an insurance contract. If the investor designated a beneficiary other than the estate the asset are distributed as insurance proceeds without estate administration tax (formerly known as probate).

Available for all Plans RRSP, RRIF, LIRA, LRIF, Tax free saving account, Non Registered and Corporate Accounts

Segregated Funds are available for all account types accept RESP's. A segregated fund is an annuity. Certain account types such as a LIRA require assets be transferred to an annuity by a certain age.

Deposits Protected by Assuris

Deposits with banks and trust companies are insured by CDIC investments with insurance companies are insured by Assuris. Assuris insures your investments in segregated funds in the following order, the first $60,000 100% insured, above $60,000 85% insured, there is no limit on the amount it is unlimited.

For guaranteed withdrawal benefits segregated fund contracts insurance is slightly different. During the accumulation phase it the same as a all other segregated fund contracts. During the payout phase when you start to make withdrawals, you are insured for a monthly benefit of up to $2,000 per month, per insurance company. 

Liquidity

You are never locked in and can access your money at any time. The amount you receive is the market value of your investment at the time of you redemption. You are not required to keep your money until maturity date or death. These are safeguards built into a segregated fund contract to provide valuable benefits and peace of mind. Any redemption charge payable to redeem is tax deductible just like a mutual fund redemption fee or commissions you pay to sell a stock in non-registered accounts. In a segregated fund it is not advantageous to sell investments if they are losing money and are below their guaranteed maturity values. If the value of the investment is below the guaranteed amount, the investor can wait until the maturity date at which time they will receive the higher value of the guaranteed amount. If the segregated funds are worth more than the guaranteed amount in the segregated fund contract the additional fees are simply the cost of having these valuable benefits. All management fees, additional insurance fees and commissions are tax deductible in non-registered accounts. 

A beneficiary is appointed for all account types

With mutual funds and brokerage accounts you can only appoint a beneficiary on your registered accounts such as RRSP’s, RRIF etc… With segregated fund contracts you can appoint a beneficiary for all account types including non-registered accounts. The only exceptions are corporate accounts where the beneficiary is the corporation.

Can be used for leveraged accounts (investment loans)

We have all heard borrow to invest not to consume. Interest on investment loans is tax deductible even if your money is never at risk and your principal is 100% guaranteed. CRA has ruled on this issue and has made an exception for segregated fund contracts. One of the conditions of being able to deduct interest on investment loans is there has to be an element of risk. Having your principal 100% guaranteed does not pose any risk of losing your principal in a segregated fund contract. The interest expense is a great way to obtain additional tax deductions and build wealth. There is also the benefit of tax deferral on your gains if the investment chosen has minimal turnover in the portfolio. Some portfolio managers run tax efficient portfolios to minimize tax and to enhance tax deferral of capital gains. 

Access to institutional money managers only available to large pension plans and high net worth clients

Insurance companies are the largest pension plan administrators in Canada. Many of the institutional money managers are not offered to retail clients in mutual funds and exchange traded funds. In segregated fund offerings a retail investor is able to invest and benefit from expertise in money management from institutional money managers only accessible to high net worth clients and pension plans.

Guaranteed Income for Life

The first insurance company in Canada to offer this product was Manulife. Other insurance companies followed and started to offer these products. Insurance companies are experts in forecasting mortality (life expectancy) but actuarial science cannot forecast stock market returns. This investment has two components the accumulation phase and the payout phase it is the closest investment vehicle that resembles a defined benefit pension plan.

There are many benefits to having a minimum guarantee on the payment income stream for life. The investments in equities provide good protection for inflation as an asset class.

The biggest disadvantage is the fees insurance companies charge for these benefits are high. If the investor needed to make a withdrawal they would lose any accumulated bonus in the contract and would have paid higher fees without any benefit.

Stone-Hedge Financial Group Inc. uses an approach not only for asset allocation to fund ones retirement but also product allocation to provide flexibility during one’s retirement.

Accumulation Phase

During this period one invests money into the segregated fund contract. If the investment does not make money in a given year the insurance company guarantees a bonus of 4% to 5% in their contract. This is a nominal amount it is not money the investor can redeem. In most contracts every three years there is a reset, the investor receives the market return of the underlying investments or the bonus if the market returns for that period where negative or below the guaranteed bonus rate in the contract. The bonus is very attractive in a low interest rate environment where alternative guaranteed investments have lower returns.

Payout Phase

The payout phase can be as early as age 55 or as late as age 71 in most contracts. The earlier the age the lower the guaranteed withdrawal benefit, the later the age the higher the guaranteed withdrawal benefit. The guaranteed withdrawal benefit ranges from 3.5% to 5% in most contracts. It is a lifetime benefit one receives even if there is no money left in the contract. This is what makes it similar to a defined benefit pension plan. It will continue to pay out a benefit for as long as the investor is alive.

In a defined benefit pension plans only the spouse can continue to receive the benefit, any remaining amount not used is forfeited and belongs to the pension plan. With a guaranteed income for life contract any money not used during one’s lifetime is paid out to their designated beneficiary.

The investments have the potential to grow and increase the payout benefit to the investor. Many contracts do not require the investor to wait for the payout phase after their initial investment. The investor can make a lump sum deposit and start the guaranteed lifetime withdrawal benefit immediately.

The information provided on this web site is intended for general information only. It should not be construed as legal, accounting, tax or specific insurance and investment advice. Clients should consult a professional advisor concerning their situations and any specific insurance and investment matters. While reasonable steps have been taken to ensure that this information was accurate as of the date hereof, Stone-Hedge Financial Group Inc. and its affiliates make no representation or warranty as to the accuracy of this information and assume no responsibility for reliance upon it.