A segregated fund is an investment fund that combines features from mutual funds and insurance products. They are also known as segregated or seg funds offered by life insurance companies. They allow investors to participate in the financial markets while providing certain guarantees and capital protection. Segregated funds are popular in Canada, and a few other nations, and they are similar to variable annuities in the US.
These funds combined life insurance's benefits with capital appreciation's advantages.
Because of the complexities in structure, investors should expect a somewhat higher total expense ratio when investing in segregated funds. Furthermore, these fund options avoid aggressive investment objectives, resulting in more conservative returns.
Segregated Funds Explained
Segregated funds are managed by insurance firms within separate accounts and are set up as delayed variable annuity agreements with life insurance payouts. These policies are similar to other variable annuity products offered by insurance companies. These products, which Canadian insurance companies primarily issue for the Canadian population, are not traded on the open market. Their arrangement as contracts eliminates the concept of ownership through shares or units.
The requirement for segregated funds is their retention until maturity. Investors can choose to participate in these funds based on their investing goals and the parameters of the product. The range of segregated fund options covers various objectives and underlying investment opportunities. Furthermore, they offer a variety of conditions for annuity payments and life insurance benefits to investors.
How Segregated Funds Work
Segregated funds generate capital growth by investing until a predetermined maturity date. Simultaneously, they provide a life insurance death payment if the contract holder dies before maturity. Unlike traditional mutual funds, where investors risk losing their entire investment, most segregated funds guarantee a dividend ranging from 75% to 100% of the premiums paid. This benefit applies to both the death benefit and annuity payments.
Following the maturity date, segregated funds begin making payments to investors. Upon maturity, investors can choose from various payout schedule options the financial product provides.
Segregated funds are insurance products that insurance companies sell. Therefore, the regulatory authorities overseeing these funds may be the same bodies responsible for supervising insurance companies.
Segregated Funds Examples
The Royal Bank of Canada (RBC) and Sun Life are well-known Canadian companies offering segregated funds to investors.
Royal Bank of Canada (RBC)
RBC offers a variety of segregated funds in three categories: Invest Series, Series 1, and Series 2. Each option has different underlying investments, investment allocations, and terms.
Sun Life
Sun Life offers several segregated funds options, including Sun Lifetime Advantage GIF, Sun GIF Solutions, and Sun Protect GIF. Financial experts can also help you identify segregated funds.
Advantages of Segregated Funds
Investing in segregated funds offers several advantages over other investment options. These benefits make them a valuable addition to your investment portfolio:
Protecting Your Initial Investment
One of the most appealing features of segregated funds is the assurance that your initial capital will be protected. Unlike many other investments, segregated funds guarantee a portion of your initial investment, if not the entire. This guarantee is valid as long as you follow the terms of your contract. Regardless of market changes, your principal investment is protected.
Creditor Protection Is Included
Segregated funds usually come with creditor protection. This measure protects your invested funds from creditors, even if you face financial challenges like bankruptcy. Furthermore, this protection extends to the beneficiaries of your fund, guaranteeing that their access to the assets is secure.
Streamlined Death Benefit Payouts
If you die before your contract matures, segregated funds make the procedure easy for your beneficiaries. Unlike traditional assets, which may be subject to probate, life insurance companies pay out death payments directly to your beneficiaries. This efficient and direct payment approach avoids the typically lengthy and costly probate proceedings, ensuring your loved ones receive the benefits as soon as possible.
Disadvantages of Segregated Funds
While segregated funds can help to manage investment risks, it's essential to understand that they have their own set of limitations. Consider the following segregated funds' disadvantages before investing in them:
Higher Costs
Investing in segregated funds has substantial costs that can reduce your overall profits. Unlike mutual funds, these funds are associated with different fees that can accumulate over time. These fees cover various aspects like management fees, operating costs, insurance fees, and agent fees.
Limited Accessibility
Giving your funds to an insurance company involves limited access to it. Accessing your money from a segregated fund can be challenging, especially in emergencies. Withdrawals may be costly, jeopardizing your principal guarantee and possibly subjecting you to early withdrawal penalties.
Conservative Investment Strategy
Segregated funds are intended to follow a conservative investment approach. Insurance companies prioritize risk management over aggressive growth. As a result, fund managers favor conservative investments with limited growth potential. Its focus on stability may limit prospects for significant returns.
Segregated Funds Vs. Mutual Funds
Mutual funds have become a popular tool for investors to invest in different assets easily and affordably. They provide diversification by tracking a specific market and providing active and passive management. In comparison, segregated funds are similar to mutual funds in that they have an investment component but have significant differences. Segregated funds are insurance products that are regulated in the same way as insurers are. In contrast to mutual funds, they protect against losses and guarantee a share of premiums (75-100%) on maturity or death. Beneficiaries receive the guaranteed death benefit or the fund value, whichever is greater.
