Some rules for segregated funds are changing. The Office of the Superintendent of Financial Institutions, a federal regulator, has changed the capital requirements for segregated funds. The insurance company that insures your segregated fund has to hold more capital to back the guarantee on the fund. This makes it more expensive for the insurer to offer the fund to you.
What is a segregated fund?
Like a mutual fund, a seg fund pools money from many investors so it can be managed by a professional and provide a good return. But seg funds are actually insurance contracts with two components: an investment that produces the return and an insurance contract that covers the risk. Unlike mutual funds, seg funds guarantee either 75% or 100% of your principal. A small part of the fund's assets goes to ensure there will be enough cash to pay that guarantee. Seg funds have some other advantages over mutual funds, including creditor protection. Like all insurance contracts, they allow you to name a beneficiary. After your death the fund is paid to the beneficiary without tax or probate.
Why are these changes happening?
Segregated funds guarantee either 75% or 100% of the principal you invest. The regulator is worried about the risk of market values dropping and staying low for more than 10 years. If that happened, the insurer would have to pay out large amounts to honour its guarantee. The new capital requirement ensures the insurance company has enough money to honour that guarantee for everyone even if markets are depressed for a long period.
How will segregated funds change?
It is more expensive for the insurance company to guarantee your segregated fund. As a result, it may consider one of these changes:
- Increasing the management expense ratio.
- Reducing the 100% guarantee to a 75% guarantee.
- Making the 100% guarantee an option that you pay extra for.
- Limiting the number of resets you are allowed.
- Extending the term the fund has to be held for the guarantee to be honoured.
- Offering only lower-risk funds as seg funds.
Will all segregated funds be affected?
No. Some insurance companies have already priced their products to cover the cost of these capital requirements.
What about my existing contract?
If you hold a segregated fund, you have signed a contract with the insurer. That contract sets out the terms, including the terms of the guarantee and whether you are allowed to reset the guarantee. The terms of this contract cannot be changed. However, most contracts allow companies to raise the management expense ratio (MER) of the segregated fund. They must provide 60 days' notice to you before changing the MER.
Are segregated funds still a good investment?
Yes. There are many benefits of holding segregated funds, particularly if your fund is performing well.
- Segregated funds are creditor-proof. This is a benefit if you are a sole proprietor or in partnership and want to save for your retirement without putting those funds at risk.
- Segregated funds offer estate planning benefits. You name a beneficiary and the full value of the guaranteed fund is paid to that person without probate fees after your death.
- There are no limits on the value of your segregated funds you may invest outside of Canada.
If your management expense ratio is rising, you will pay more in management fees than you originally expected over the time you hold the fund. But if a fund is performing well and fits with your investment plan, it will still be a good investment for you.
Who can help?Always check with your advisor when there is a change in your investment circumstances. Your trained Advocis advisor can explain the new rules on segregated funds and help you choose the product that meets your financial needs.