Segregated Fund is a kind of investment fund governed by Canadian insurance companies in the shape of individual and variable life insurance contracts providing some guarantees to the policyholder like refund of capital amount upon death. As a pre-requisite, these funds are entirely different from the company's general investment funds hence it is termed as segregated fund. Segregated Fund is identical to the U.S. insurance sector "separate account" and allied annuity and insurance products.
A segregated fund is an investment policy that is a fusion of the growth possibilities of a mutual fund and the security of a life insurance policy. Like mutual funds, these funds comprises of a collection of investments in securities viz. debentures, bonds, and stocks. The value of the segregated fund remains volatile based on the market value of the underlying securities.
Shares of units are not issued by segregated funds; hence, a segregated fund holder is not called to be a unit holder. Instead, the segregated fund holder is the owner of a segregated fund contract. Contracts may be registered or non-registered based on whether or not it is held inside an RRSP. Registered investments are eligible for yearly tax-sheltered RRSP contributions. Investments that are non-registered are liable to tax payments on the capital gains every year and can also claim capital losses.
These funds are sold in the form of deferred variable annuity contracts and only licensed insurance representatives can sell these funds. These funds are possessed by the life insurance company, not any individual investors, and must be kept apart from the company’s other policies and assets. It consists of underlying assets that are purchased from life assurance companies. Investors do not carry any rights to ownership share. These funds are guaranteed and last for a certain period. Should the investor surrender before the end date, he/she may be penalized.
All segregated fund contracts manifests a maturity date, which should not be confused with maturity guarantees as it is entirely different from maturity guarantee. The date of maturity is that specific date on which the guarantee of maturity is provided to the fund holder. Holding time to reach maturity are generally 10+ years.
Guarantee funds are provided in all segregated funds wherein a certain percentage of the capital investment in a contract (usually 75% or more) will be paid out at death or the maturity of the contract. In either case, the beneficiary will gain the greater pay out of the guarantee or the investment’s existing market value.
If a beneficiary is nominated, the segregated fund investment can be exempted from executor’s fees and probate and can be delivered directly to the beneficiary. If the nominated beneficiary is a family member (like spouse, parent, or child) the investment may also be protected from creditors in the event of bankruptcy. These protections are applied on both registered and non-registered investments.
If certain qualifications are satisfied, segregated fund investments can be protected from seizure from creditors. This is one of the important features for business holder or professionals whose assets are having a high exposure to creditors.
A reset option enables the contract holder to lock the investment profits if the market value of a segregated fund contract accelerates. This resets the contract’s capital/deposit value to parallel the current market value or greater of the deposit value, redefines the contract term, and elongates the maturity date. Contract holders are restricted to a certain number of resets, generally one or two, in a specific calendar year.
The smaller the term of the maturity guarantees on investment funds irrespective of its being segregated funds or protected mutual funds, the greater is the risk exposure of the contractor and the cost of the guarantees. This reciprocal relationship is based on the premise that there is a bigger possibility of market decline (and hence a bigger chance of collecting on a guarantee) over small durations. A contract holder's facilitations of reset provisions also adds to costs, since resetting the guaranteed capital at a higher level goes to say that the issuer will be liable for such higher amount.
Investors can generally withdraw 10% of the investment capital every year without paying any penalty. The figure increases to 20% in case these funds are held in any retirement account.
The method of fund transfer is rapid and inexpensive as the investment in segregated funds is not subject to probate. The funds are directly credited to the account holder or the beneficiary.
There are a few disadvantages also linked with segregated funds:
In a nutshell, segregated funds offer a great investment opportunity for all with ample space for growth and protection from losses.