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Imagine the scenario where you could make an investment that offers a chance for growth in the financial markets and comes with a guarantee that it won’t lose money. No, it’s not the stuff of dreams. In the real world this is called a segregated fund and you can get one if you are a Canadian citizen.
Now that we’re all excited, let’s go. Segregated funds are professionally managed portfolios provided by insurance companies that offer a guaranteed return upon maturity or death of the investor. The odd name is based on the fact that these funds are not part of the assets of the insurance company 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 types of objectives to choose from, profits are taxed unless these funds are held in a retirement. 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 at least 10 years.
In addition to the guaranteed return, segregated funds have a few other advantages:
1) Reset Options – Most segregated funds have the ability to “reset” the investment amount to include gains made in the portfolio. Their usually a maximum number of increases allowed depending on the contract and also the increase in amount could extend the maturity date of the investment.
2) Protection from creditors – As long as the annuity contract has been in existence for at least two years and inheritance tax is not due, the investment held in segregated funds is not available to creditors. Even if the account holder goes bankrupt or faces other financial hardship, life insurance beneficiaries have first annuity rights.
3) Liquidity – Investors can generally withdraw up to 10% of the investment amount each year without penalty. If these funds are held in retirement accounts, this figure increases to 20%.
4) Estate Planning – Wealth transfer process is faster and cheaper because investing in segregated funds is not subject to probate. Funds go directly to the account holder or beneficiary.
As expected, there are a few disadvantages associated with segregated funds:
1) The investment cost is higher than that of mutual funds.
2) Prepayments above the limits generally incur penalties of up to 6% in the first year, but decrease from 1% in subsequent years to 0%.
3) If you decide to change your investment area, additional fees may apply and the number of times you can make such transfers is limited.
Overall, segregated funds offer a great investment opportunity for everyone with room for growth and protection against losses.