Investing? Segregated funds are often a misunderstood product. They can be a valuable tool in certain circumstances but are not always suitable for everyone. Here are the pros and cons of seg funds that may help you decide if they are right for you.
What are segregated funds?
A segregated (seg) fund is basically a blend of a mutual fund and an insurance policy. They are investment products sold by insurance companies that combine the growth-potential of investing with the protection of insurance. Segregated funds have two parts. (1) They are pooled investments, like mutual funds (available in various account type; RRSPs, TFSAs, non-registered, RRIFs, LIRAs and LIFs) allowing investors access to diversified portfolios managed by professionals. (2) In addition, segregated funds include insurance guarantees that protect most or all of your original investment.
Seg fund Pros:
- Guaranteed protection of 75-100% of your principal investment upon maturity of the contract (which is usually 10 or 15 years). This can be appealing for risk adverse investors because it provides protection against fluctuating markets.
- Option to lock-in your capital gains. Many seg funds provide several opportunities for you to reset the fund’s guaranteed values. This guarantee can add peace of mind during the lead up to retirement.
- Death benefit guarantee. If you pass away before the contract expiry date, the named beneficiary/beneficiaries to your fund will receive the market value of the investment or the guaranteed amount, whichever is higher at the time of your death. This money is tax-free and by-passes probate much like a life insurance policy benefit.
- Creditor protection. Assets within the segregated fund policy, registered or non-registered, can be protected from creditors if a specific type of beneficiary is named (a spouse or a child). This is often beneficial for business owners or self-employed individuals.
Seg fund Cons:
- Higher fees. To cover the cost of the insurance component, segregated funds fees (MER) are higher than a traditional mutual fund. Although, providers have worked to reduce their fees in recent years so that they will be closer to those of mutual funds.
- Money may be locked into the contract. Investors have to keep their money in the segregated fund until the maturity date in order to take advantage of the guarantees.
- Early withdrawals may incur penalties and can affect future guarantee values.
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