Segregated funds
What are segregated funds?
Segregated funds
, or Individual Variable Insurance Contracts (IVICs), are pools of investments, similar to mutual funds, but sold in combination with insurance. Insurance companies create some segregated funds, while others are created based on existing mutual funds, with an additional insurance element. These funds generally have higher fees than mutual funds to cover the cost of the insurance features. They offer full or partial principal guarantees if held until they mature or until the fund holder passes away. They also offer creditor protection and can be useful in estate planning.
Segregated funds offer protection from creditors. This means that if you go bankrupt, or fail to pay your debts, creditors cannot touch the money in this fund, unless you have opened this fund in anticipation of going bankrupt. This feature may not matter as much if your segregated fund is in a Registered Retirement Savings Plan (RRSP) or Registered Retirement Investment Fund (RRIF) since they already offer this protection, at least in the case of bankruptcy.
If you are thinking about buying a segregated fund, be sure to ask your insurance agent about Fund Facts, a document that highlights key information about the fund. It should be available on the fund company’s website, or you can request it from the person selling you the fund.
What risks do they have?
Segregated funds have low to moderate risk. Segregated funds take some of the risk out of investing because they offer a guaranteed return if you hold the fund until your contract matures (usually between 10 and 20 years). However, if you need to sell before the maturity date, nothing is guaranteed.
A ‘seg’ fund’s risk stems from the investments it holds. If the investments do well, then you will get good returns. But if the fund manager makes bad investment decisions or bad market conditions cause the fund to perform poorly, then you risk losing money on your investment if you sell before it matures.
Can you sell them easily?
Yes. It’s easy to sell segregated funds back to the fund company, but if you sell before the maturity date, you receive market price for your units, minus any fees you owe. This could mean you lose money.
What are the associated costs?
Segregated funds have significantly higher management expense ratios (MERs) than mutual funds. The MER you pay for segregated funds is higher for funds that offer higher guaranteed returns because of the built in insurance benefit.
There are also sales fees associated with the purchase of any investment fund. See Fees.
What are the expected type of returns?
Segregated funds earn interest, dividends, and capital gains like mutual funds. The fund grows by retaining and reinvesting the earnings. Certain funds have a Guaranteed Minimum Withdrawal Benefit (GMWB).
A feature unique to many segregated funds is the reset option. This means that if the value of the fund has gone up you may be able to lock in that increased value and receive at least the guaranteed percentage of that increased value provided you hold the fund to the maturity date. If you choose this option, the fund company will extend the maturity date as well.
If you sell your units back to the fund company, you will receive market value for your investment, minus any fees you owe. You will earn capital gains if the fund has made money, or capital losses if the fund has lost money.
Segregated funds have a maturity and death guarantee. This means that if you hold the fund until it matures, the fund company will pay you 75% to 100% of your principal investment. If the fund holder of the fund passes away, the named beneficiary gets a guaranteed minimum amount based on the life insurance associated with the fund. The beneficiary gets the money directly and avoids probate fees and executor fees.