Benefits of Segregated Funds
I regularly discuss segregated funds* with my clients and discuss how they differ from the much more widely known mutual funds. It still amazes me how many investors in Canada have never heard of these great alternatives and the unique benefits that they offer.
A segregated fund is an investment fund that in most ways, is identical to a mutual fund. For example, you can invest in the Fidelity Dividend Fund as a mutual fund or a segregated fund. The same fund manager is investing the entire pool of money and they invest the entire sum as a whole. The underlying investments in the two funds are identical and they produce the same results.
They key difference is that they are administrated under the insurance act instead of the bank act. This provides several great benefits that are not available on the mutual fund side.
The first key difference is that segregated funds bypass the estate and they pass directly on to your beneficiaries. Doing so allows you to pass your remaining estates funds directly to your children (or whoever you chose) and not pay any estate, probate or other professional fees on it. If there are taxes owing, they will still be due but the other savings means you can still pass on a much larger amount to your chosen beneficiaries. In addition to passing on a larger amount of money, the funds will also be available much more quickly as they won’t be held up in probate for 6-12 months or more. This provides your family with immediate liquidity so that they can settle your final affairs. For individuals with a shortened life expectancy, the segregated funds offer a great way to simplify your estate and make sure your wishes are properly followed.
The second important benefit is that segregated funds provide significant potential creditor protection. If you are to ever find yourself named in a lawsuit down the road, you can help to ensure that your segregated fund account will be safe. Under the insurance act, a potential creditor cannot lay claim to your segregated fund accounts the same way they potentially can with your mutual funds. This protection can provide significant levels of protection for professionals or others who may face liability in their work or personal lives. It’s important to note that the creditor protection offered needs to be fully understood and best discussed with an advisor that fully understands what it can offer.
Many people don’t realize that probate is a public process and in addition to costing a lot of money, it puts much of your financial affairs out in the full view of anyone who wants to see it. Utilizing segregated funds and naming a beneficiary on the accounts allow you to keep your financial affairs private.
Segregated funds also offer some great tax savings and reporting benefits. Unlike mutual funds, the tax information is tracked and reported by the issuing company which greatly simplifies the annual tax filing process for non-registered accounts. Additionally, income allocation does not result in an increase in units and a corresponding drop in price which avoids potential double taxation from withdrawals.
On top of the benefits listed above that are features of all segregated funds, most fund companies offer additional guarantees and features that should be fully explained and discussed before considering. Most offer some great value but they generally all come at a cost.
So what’s the catch? While some uninformed voices may say that these funds are not worth it because they cost a lot more, the truth is that they often don’t. A basic segregated fund can cost the exact same to maybe 0.2% more in annual management fees. Fee conscious investors can definitely build a portfolio for the same costs they’re paying now. The extra costs only come when you start adding additional features and guarantees. While some of these extra options have great value, it’s something that needs to be fully understood.
Segregated funds are not for everyone but they do offer some great alternatives that you should explore, particularly if you are retired or close to retirement. If you want more information, feel free to send me an email to see if they make sense for you.
Important note: Insurance products provided through multiple insurance carriers.
Mutual funds and some segregated funds products are offered through Investia Financial Services Inc.
*Segregated funds: Subject to any applicable death benefit guarantee, any part of the premium or other amount that is allocated to any applicable death benefit guarantee, any part of the premium or other amount that is allocated to a segregated fund, is invested at the risk of the policy owner and may increase or decrease in value according to the fluctuations in the market value of the assets of the segregated fund.