Segregated funds are unique investment products that combine features of mutual funds with the protection of insurance contracts. These funds are offered exclusively in Canada by insurance companies and are governed by insurance legislation.
They are designed to provide both investment growth and certain guarantees. As such, they’re an attractive option for investors who want growth potential with added security. In this article, Wealth Professional Canada will shed light on what you need to know about segregated funds.
A segregated fund pools money from many investors to buy a diversified portfolio of assets, such as stocks, bonds, or other securities. What sets segregated funds apart is the insurance contract that wraps around the investment.
When a client invests in a segregated fund, they are purchasing an insurance contract rather than a direct share of the fund’s assets. The insurance company manages the fund and provides guarantees on the principal or death benefit, depending on the contract terms.
Watch this video to learn more about segregated funds and see if they’ll fit your clients’ financial profile and investment objectives:
As mentioned above, a huge advantage of segregated funds from other investment vehicles is that they offer life insurance benefits. This contract provides guarantees that are not available with traditional mutual funds.
Segregated funds can be a good investment for clients who want growth potential with added protection. They offer guarantees on principal and death benefits, which can provide peace of mind during market downturns.
However, segregated funds usually have higher fees than mutual funds and might not be suitable for those focused on maximizing returns. They are best for clients who value estate planning advantages and creditor protection over lower costs or higher growth.
Yes, your clients can cash out their segregated funds before maturity. Remind them that there might be penalties or redemption fees, especially if they withdraw early. The value that your clients receive will be based on the current market value of the fund, not the guaranteed amount.
An exception will be holding the investment until the maturity date or death. Always review the contract terms to guide your clients and help them understand any charges or impacts on guarantees before making a withdrawal.
Let's look at some features of segregated funds to see why they differ from other funds:
One of the main attractions of segregated funds is the guarantee on the principal. Most segregated funds offer a guarantee of 75 percent or 100 percent of the original investment, either at maturity or upon the death of the contract holder.
This means that even if the underlying investments lose value, your clients are assured of getting back at least the guaranteed amount. This is based on the requirement that they hold the investment until the maturity date or until death.
Segregated funds also provide a death benefit guarantee. If the contract holder dies, their beneficiary will receive at least the guaranteed amount, regardless of how the investments have performed.
This feature is especially appealing to clients who want to leave a legacy or be certain that their loved ones are protected from market downturns.
A maturity guarantee ensures that after a set period, usually ten years, your clients will receive at least the guaranteed portion of their original investment. If the market value is higher than the guarantee, the client receives the higher amount.
Because segregated funds are insurance contracts, they might offer creditor protection. If the contract names a family member as the beneficiary, the investment might be protected from creditors in the event of bankruptcy or legal action.
This feature is particularly valuable for business owners and professionals who face higher liability risks.
Segregated funds allow the contract holder to name a beneficiary. When the contract holder dies, the proceeds go directly to the beneficiary, bypassing the probate process. This can speed up the transfer of assets and reduce legal costs.
Some segregated fund contracts allow for resets. This means the guaranteed amount can be increased if the market value of the investment rises. For example, if the fund performs well, the guarantee can be reset to the higher value. This locks in gains for future guarantees.
Now that you’ve learned about its features, watch this video to see whether segregated funds are right for your clients:
It is vital for you to assess whether a segregated fund is suitable for your clients. Obviously, not every investor will benefit from the features of the same investment vehicle. As such, use a personalized approach to make sure that the chosen products align with your clients’ needs and preferences.
Once a client has invested in a segregated fund, regular contract reviews are important. Life circumstances and financial goals can change, so you should schedule periodic check-ins to confirm that the segregated fund still fits your clients’ objectives. Adjustments might be needed as clients approach retirement or as market conditions evolve.
A Guaranteed Investment Certificate (GIC) is a fixed-income product that guarantees the return of principal plus interest over a set period. As we mentioned, segregated funds are investment funds with insurance features. They offer market exposure and guarantee on principal or death benefits.
GICs have no market risk but offer lower returns. Segregated funds have higher risk and potential for growth, but also higher fees. GICs do not provide estate planning or creditor protection features like segregated funds.
Segregated funds are not suitable for every client. They are best suited for individuals who want guarantees and protection, even if it means paying higher fees. Usual clients include:
Below are some upsides that your clients can enjoy if they invest in segregated funds:
Security and peace of mind: The guarantees provided by segregated funds offer peace of mind to clients who are concerned about market volatility. Knowing that a portion or all their investment is protected can help your clients stay calm during turbulent times
Estate planning benefits: Segregated funds simplify estate planning by allowing direct beneficiary designations. This can help avoid delays and legal fees associated with probate
Potential creditor protection: For business owners and professionals, the creditor protection offered by segregated funds can safeguard personal assets from business risks
Professional management: Like mutual funds, segregated funds are managed by professional portfolio managers. Your clients will definitely benefit from diversification and expertise
Despite the upsides listed above, there are still some downsides to this investment vehicle:
Higher fees: The insurance guarantees and features come at a cost. Segregated funds usually have higher management expense ratios (MERs) than comparable mutual funds. Your clients should weigh the value of the guarantees against the additional cost
Limited liquidity: Segregated funds might have redemption fees or penalties for early withdrawals, especially if the investment is cashed out before the maturity date. That’s why you need to review contract terms carefully with your clients
Complexity: The insurance features and guarantees can make segregated funds more complex than traditional investments. Make sure that your clients understand the terms, conditions, and limitations
If you're a financial advisor, you need to take the time to explain how segregated funds work, using clear and simple language. This includes outlining the benefits such as principal guarantees and estate planning advantages.
You must also remind clients of the limitations, like higher fees and possible penalties for early withdrawals. Providing written materials and visual aids can help reinforce these concepts.
Segregated funds offer a unique combination of investment growth and insurance protection. Assessing what these products can offer is vital if you want to attract clients who value security and estate planning benefits. The same is true for those seeking creditor protection.
While segregated funds are not suitable for every investor, they can have a valuable role in a well-rounded financial plan.
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