Segregated funds: is a segregated fund a perfect investment opportunity?

Imagine the scenario where you could make an investment that has the opportunity to grow in the financial markets and comes with a guarantee that you won’t lose any money. No, this is not a dream thing. In the real world it’s called a segregated fund and you can get one if you’re a Canadian citizen.

Now that we’re all excited, let’s get right to the point. Segregated funds are professionally managed portfolios provided by insurance companies that have a guaranteed return upon expiration or death of the investor. The strange name is based on the fact that these funds are not part of the insurance company’s assets, but rather a separate pool of money dedicated to paying policyholders.

These funds are similar to mutual funds in that they are professionally managed, offer diversification, have a variety of different focus types to choose from, earnings are taxable unless these funds are held in a retirement account. The big difference is that segregated funds are variable annuity contracts provided by life insurance companies that generally guarantee a return of at least 75% if held for a period of at least 10 years.

In addition to the guaranteed return, there are a few other benefits of segregated funds:

1) Reset Options – Most segregated funds have the option to “reset” the investment amount to include any earnings earned in the portfolio. They usually have a maximum number of increases allowed depending on the contract and also the increase in the amount could extend the expiration date of the investment.

2) Creditor Protection: As long as the annuity contract has been in existence for at least two years and no estate taxes are due, creditors will not be able to access the investment held in segregated funds. Even if the account holder files for bankruptcy or other financial hardship, life insurance beneficiaries have first rights to the annuity.

3) Liquidity: Investors can normally withdraw up to 10% of the investment amount each year without penalty. If these funds are kept in retirement accounts, this figure increases to 20%.

4) Estate planning: the wealth transfer process is faster and cheaper because investment in segregated funds is not subject to legalization. Funds go directly to the account holder or beneficiary.

Unsurprisingly, there are some downsides associated with segregated funds:

1) The cost of investing is higher than that of mutual funds.

2) Early repayments above the limits usually have penalties of up to 6% the first year but decrease by 1% in subsequent years to 0%.

3) If you decide to change the investment area, there may be additional fees and there is a limit to the number of times you can initiate such transfers.

In general, segregated funds provide a great investment opportunity for everyone with room for growth and protection against loss.