In this week’s CH Minute, we continue our series on risk mitigation strategies with the micro approach where we focus on risk mitigation of a pool of investments through segregated funds.
What is a segregated fund?
Segregated funds are like mutual funds in that they hold a pool of stocks and bonds, but they have one unique characteristic which is that segregated funds include insurance guarantees which can protect some of the capital that a client put into it.
How do segregated funds work?
Segregated funds are managed by insurance companies. Specific investments held within them can be managed by any fund company that has been approved by that insurance provider. For example, XYZ Fund Company may offer a mutual fund called XYZ Global Growth and the insurance company will offer it as the XYZ Global Growth Segregated fund. The mandates and how the two funds invest are the same, the only difference is that the segregated fund has an insurance contract attached.
Segregated fund contracts have a maturity guarantee that applies on the maturity date of the contract and a death benefit guarantee that applies throughout the entire term of the contract. Guarantees usually range from 75% to 100% of the fund’s value.
To illustrate, say a client wishes to purchase a segregated fund that invests in Canadian equities and has a 100% maturity guarantee on death. If the client’s initial investment is $100,000 and they do not contribute or withdraw from the fund, then a couple things happen:
1) If the market value on the date of death has dropped to $80,000 the value of the fund is “topped up” by the insurance company so that it will pay out $100,000 to the fund’s beneficiaries. This payout will flow outside the Will if it is held in a non-registered account since the payout is from an insurance contract.
2) If the market value on death is $110,000, the market value would now be higher than the guarantee so the beneficiaries will receive the market value.
The maturity guarantee works in much the same way as the death benefit and is determined on the day the contract “matures”. This guaranteed amount is paid to the owner of the policy and can be reinvested or cashed out.
What are some other features of segregated funds?
The maturity guarantee and death benefit are features that separate a segregated fund from a mutual fund. More unique features include:
· They do not require medical underwriting.
· Some segregated funds may offer resets, which is the ability to “lock-in” a rising market value.
· Death benefits can be paid out to the beneficiary without having funds flow through a client’s estate and can thus avoid probate.
· They offer protection from Assuris who guarantees that the contract owner will receive up to 85% of the contract’s guarantees if the insurance company cannot. For policies that have a guaranteed amount of $60,000 or less, the policyholder will retain 100% of the amount invested.
· Segregated funds can also provide creditor protection. Since the segregated fund is an insurance contract, creditor claims won’t be successful if there is a designated preferred beneficiary.
There are many reasons and situations where segregated funds may be suitable for a client, whether it is for estate planning or to guarantee the preservation of capital. CH Financial offers segregated funds along with many other product offerings in its holistic approach to wealth management. If you would like to learn more about segregated funds, please reach out to your wealth advisor who will be happy to discuss with you.
As always, we welcome any questions or comments.
All the best,
Devin Gorgchuck, Wealth Advisor
& Your CH Financial Team