While both segregated funds and mutual funds are popular choices for investors, they aren’t the same thing. Mutual funds are a way for investors to combine all of their money together in a fund managed by an investment firm. This limits exposure, which can help mitigate any risks. Segregated funds are similar except for the fact that they have insurance guarantees that can help protect your funds.
Segregated Funds Vs EFTs
While Segregated Funds and EFTs are similar, they aren’t the same thing.
EFTs: These also known as Exchange-Traded Funds, are similar to mutual funds. They allow investors to pool their money into a diverse basket of securities. The ETF is then traded on the stock market like a traditional stock. The idea behind an ETF is to track a specific index, which means there is no guarantee on your investment, and you’re taking a risk with your investment due to market volatility.
Segregated Funds: They work similarly to this, except they’re not a public security like an ETF. They have an insurance aspect that guarantees your fund. This makes them much more secure than a mutual fund or an ETF. However, the growth market is smaller than that of an ETF or a mutual fund.
How Do Segregated Funds Work?
Segregated funds are different from your traditional investments. In fact, they aren’t really investments at all. Segregated funds are offered through Canadian insurance companies and are technically considered to be an insurance product. They allow you to combine capital appreciation and life insurance through something referred to as deferred individual variable annuity contracts. They also trigger an estate freeze which can help you bypass probate.
These types of funds differ from traditional insurance products because they allow those who invest to get anywhere from 75% to 100% of their insurance premiums returned. These types of accounts tend to be managed by insurance companies in separate accounts, and they aren’t able to be traded on public markets.
Unlike traditional investments, segregated funds are structured differently as well. They are contract investments, and you don’t just own partial shares of them. Due to this, you do have to hold the funds until they reach their maturity date. However, there are different types of segregated funds to choose from, so you do get a say in the terms as well as the payments. You can also choose to set up a systematic withdrawal plan.
With segregated funds, instead of a contingent beneficiary, you can also have a successor annuitant where a designated spouse or common-law partner can automatically step in and take over the contract upon death. You can also set up an irrevocabale designation which is a beneficiary that can’t be changed, removed or altered without written consent from the beneficiary.
An Example of Segregated Funds
While there are many different types of segregated funds out there, the most common are the ones that insurance companies use. This type of segregated fund guarantees you up to 100% of your investment back once your policy reaches maturity. The specifics, though, are based on the specific terms of your segregated fund. However, many banks also offer GIFs (Guaranteed Investment Funds), which are also considered segregated funds.
Returns of Segregated Funds Vs Mutual Funds
As we’ve already mentioned, segregated funds are considered more of an insurance product than an actual investment tool. Mutual funds, however, are considered investment tools and are traded on the public market. They’re commonly used for retirement investments and can be invested in registered and non-registered accounts.
When it comes to mutual funds, you get to choose your risk level. Those who aren’t looking for long-term investments tend to choose a lower risk, while those who invest long-term choose higher-risk mutual funds. Another thing to consider is that, unlike mutual funds, segregated funds have almost no risk to the principal investment compared to mutual funds. Still, you can’t access them until they reach maturity. Usually, this is with a death benefit guarantee, meaning you don’t actually get the funds, but your beneficiary does.
What are the Fees for Both Types of Funds?
With both mutual funds and segregated funds, there are going to be fees. Whether you invest with a big company like Royal Bank, large insurance companies, or even professional portfolio managers, these fees are something you need to consider. With mutual funds, the fees are primarily charged through the MER or Management Expense Ratio. Since market value and market fluctuations can already impact your current market value, MERs can cut into your profit margins.
Even though the current market value of segregated funds works differently from that of mutual funds, they also charge an MER which has the trailing commission built in. However, this MER is often a few percentage points larger than that of a mutual fund. This MER often covers unique costs like estate planning features and principal protections, which are some of the key differences between these two funds.
With mutual fund fees, though, you also need to consider whether you’re purchasing Series F units as well as which mutual fund dealer you’re using. Ultimately, these fees will impact your fee drag, so it’s important to pay attention to the cost.
Disadvantages of Segregated Funds
One of the largest disadvantages of segregated funds through an insurance company is the higher fees. Because it’s technically an insurance contract, there are major penalties and the potential loss of the guaranteed amount of your original investment if you try to withdraw your funds early. There are also limited investment options with segregated funds, which can be difficult for those with a large investment portfolio.
Advantages of Segregated Funds
Segregated funds are a great way to distribute wealth through investments to a named beneficiary. Here are some advantages as to why investors choose them.
- They reduce the risk of probate fees and let the beneficiary receive more of the funds upon death.
- With a maturity guarantee or a death guarantee, either the beneficiary or the investor will receive the investor’s funds with little to no risk.
It’s a great choice for capital protection, creditor protection, and a quick settlement upon death.
How Does Tax Work on Segregated Funds?
Taxes on segregated funds work similarly to those of other investments. However, because it’s an investment tool as well as an insurance contract, the investor is responsible for all taxes, not the beneficiary. The type of taxes that need to be paid depends on how your fund works. Depending on the investment you could have dividends or capital gains and losses.
Dividends : Just like with most investments, any interest income is fully taxable. In some cases, you may have eligible dividends that are taxed as usual (based on the grossed-up value) and capital gains that have their own capital gains tax. The main difference between the taxes on segregated funds and mutual funds is when it comes to capital losses. These are recognized and contained within a mutual fund, but this isn’t the case with segregated funds.
Capital Losses: For capital losses, with segregated funds, you actually have a choice on what you wish to do with them. You can choose to carry them forward to another tax year, use them towards any of the 3 previous tax years, or claim them on your current tax year. Either way, you’re able to claim them.
What Are The 75/75, 75/100, and 100/100 Guarantees?
In simple terms, these are know as limit orders.Specifically they’re standard ratios for limit orders. In fact, there are buy limit orders and sell limit orders. For a buy limit order, if it’s set below the current market price and ensures that you won’t pay more than your set price. With a sell limit order, you can set it above the current market price so it ensures you won’t sell for less than your set price. This is an alternative that many use to dollar-cost averaging.
How the Annual Reset Option Works
With segregated funds, you have the annual reset option which is also referred to as portfolio rebalancing. This allows the policyholder to upgrade the contracts guaranteed value once per year in order to match your investment’s higher market value. This locks in contract holders guarantee level in case the market drops. However, thai will also extend your maturity date.
Which Should You Choose: Segregated Funds Over Mutual Funds?
While both segregated funds and mutual funds are great options, there are many reason swjy you would choose one or the other. Here are a few of the reasons.
| Segregated Funds | Mutual Funds |
| Principal guarantees | Lower management fees |
| The ability to bypass probate | Higher growth potential |
| Creditor protection | No insurance features |
| Perfect for estate planning | Lower management expense ratios |
| Hold individual variable insurance contracts | Have some protection in specific registered plans |
Holding Segregated Funds Inside a TFSA
In order to get tax-free growth, the best place to hold your segregated funds is in a TFSA. This means that any many made within the fund is going to grow tax-free. This way you get the benefits of an investmen along with the insurance benefits.
Fund Facts and Information Folders
If you’re looking into segregated funds, then it’s important to know about fund facts and information folders. These are regulatory guidelines that are used in investing. Specifically, information folders go over the contractual rules as well as the features of investment plans. Fund facts, on the other hand, show a summary of the specific fund which includes:
- Performance
- Holdings
- Risks
- Fees
The Differences Between Segregated Fund Maturity Dates
With seg funds, you can get maturity dates that range from 10-15 years from when you make the deposit or when the investor reaches a certain age. On this date, you will have principal guarantee of 75% to 100% of your principal investment, or the current market value, whichever is higher.
When it comes to the contract’s maturity date, your maturity guarantee ensures that the funds are paid directly to the person specified in the policy. By doing this with life insurance policies instead of other investment methods, you can bypass probate while taking advantage of other key features.
Essentially, no matter your maturity date, you get market downturn protection, as well as potential creditor protection. The biggest difference between the years is when you’re lock-in period ends and you’re able the full funds without having to pay any surrender charges. It also impacts your investment time horizon which can be determined using a risk tolerance questionnaire. Investing in a target-date fund, or other fund, is determined at the same time.
How Do T3 Slips and Annual Income Allocations Work?
A T3 slip is also known as a Statement of Trust Income Allocations and Designations. It reports income that a trust or mutual fund allocates you as a beneficiary. You need this becasue you will pay tax on this as part of your annual income.
How Segregated Funds Work for Incorporated Business Owners
If you own an incorporated business in Canada, this includes small business owners, you can still invest in seg funds. The main idea of these is to act like mutual funds, but with built in guarantees at maturity or death. Specifically for business owners, this type of investment offers:
- Unique risk mitigation
- Estate planning
- Creditor-shielding avantages
Assurus and How They Protect Segregated Funds
Assuris coverage in Canada protects Canadian policy holders in case their life and health insurance company fails. For segragated funds, specifically, you can keep up to $100,000 or 90% of your guaranteed minimum withdrawal benefit. Plus, if your contract transitions into a payout phase with the guaranteed income benefit (life income benefit) for up to $5,000 per month or 90% of the promised income benefit (whichever is higher). This is done with a top-up deposit.
How Deferred Sales Charges and No-Load Purchase Options Work
Deferred sales charges are charges with a back-end load when you sell mutual fund shares early. No-load funds are when you purchase and sell shares with no commission so 100% of your money is able to work. The front-end load is when you pay the fee upfront when you purchase an investment fund.
Where Can You Purchase Segregated Funds?
In Canada, you can only purchase segregated funds from those with an LLQP licence. This insurance licensing is the training and exam process required to sell life insurance, annuities and segregated funds.
In order to get your LLQP license, you need to create a profile on the Canadian Insurance Perticipant Registry (CIPR). Once you complete the course, with an approved provider, you need to pass with a score of 60% or higher. You then need to book and pass the provincial regulators exam. You can submit your final licensing application after you secure sponsorship from an insurance firm or company that is registered with OSFI.
Some places you can purchase them are:
- Empire Life
- Desjardins Insurance
- Equitable Life
Unfortunately, you can’t do so with a discount brokerage or a robo advisor. However, there are many factors to consider, as well as other benefits and past performance, when choosing as fund and where to purchase it.
