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Lawton Partners Financial Planning

Get acquainted with segregated funds: An insurance-based investment that for some, is a perfect fit.

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The financial world uses a language that can be confusing for people who don’t have a deep understanding of investing. It can be more difficult when it comes to a particular product they may have heard of, but don’t have a firm grasp on its intent or how it works. Segregated funds are a unique kind of investment product and getting acquainted with a few key terms can help boost your knowledge.   

Segregated fund contract: A pool of investments held by an insurance company and managed separately from its other investments. A segregated fund contract combines the growth potential offered by a broad range of investment funds with the unique wealth protection and estate planning features of an insurance contract. Segregated fund contracts can help transfer wealth to the next generation quickly, privately, and cost effectively. They can also minimize exposure to risk through various guarantees, such as death and maturity guarantees, and provide potential creditor protection – all from a single product or insurance contract. But what do each of these terms mean? Let’s break it down: 

Estate planning benefits: Because segregated funds are technically insurance contracts, they let investors name a beneficiary to allow the investment to bypass probate and the estate at death.  Probate is a legal process that certifies the validity of a will and the authority of the executor(s) to facilitate the transfers of assets to heirs. It can take time – months, or even years – and in many cases, there are fees. With segregated fund contracts, the money goes directly and quickly to the person who inherits the money (the beneficiary of the contract). While poor estate planning can erode your wealth for the next generation and cause distressing, potentially expensive delays, segregated fund contracts can help make sure your beneficiaries will receive their inheritance quickly and cost-effectively. They may also help to preserve confidentiality: wills can become public documents, and the information in them can be easily accessed. Segregated fund contracts are private. 

Creditor protection: Segregated fund contracts have the potential to protect your assets from creditors. If a family class or irrevocable beneficiary to the contract is named, the segregated fund contract may be protected from the owner’s creditors during his/her lifetime. Also, the death benefit is excluded from the owner’s estate as it is paid directly to the beneficiary, usually placing it beyond the reach of estate creditors. You can read more about estate planning and creditor protection and about how the regulations particularly apply in Quebec. More insights on the creditor protection for business owners is available here.

Maturity guarantee: With a segregated fund contract, you’re guaranteed to receive at least 75 per cent of your deposits (or 100 per cent, depending on the contract), reduced for any withdrawals, when the contract matures. This is known as a maturity guarantee, and it applies at the maturity date (which occurs after a minimum number of years has elapsed or at a contract set date – for example, age 100 of the annuitant), even if markets decline during the contract period. And if markets rise, your savings grow. Some contracts even let you “reset” your maturity guarantee to lock in growth. This way, you get the opportunity to protect your capital along with growth potential. 

Death benefit guarantee: Segregated fund contracts also include a death benefit guarantee. The guarantee can be up to 100 per cent of your deposit, again reduced for withdrawals, depending on the type of contract selected and the age of the annuitant when the product is purchased. Your named beneficiary, who can be anyone – a family member, friend or charity – receives the death benefit in the event of death. As with maturity guarantees, some contracts “reset” the death benefit guarantee to lock in growth. 

Segregated fund fees: The guarantees and benefits of a segregated fund contract are a type of insurance, which you’re paying for. Segregated fund costs include management fees, insurance fees, operating costs and applicable sales tax. A contract might also include a charge for early withdrawal. 

Segregated fund contract who’s who

Contract/policy owner: The person who enters into and owns a segregated fund contract. 

Annuitant: In provinces other than Quebec, this is the person on whose life the maturity guarantee and death benefit guarantee are based. In Quebec this person is called the life insured (‘insured’) and the word ‘annuitant’ instead refers to the person who will receive the payments. For registered contracts, the contract owner and annuitant/insured must be the same person. For non-registered contracts, they can be the same, or the contract owner can decide to designate another person as the annuitant/insured. The contract owner is the person who will receive the funds at maturity of the segregated fund contract. The beneficiary is who will receive the funds when the annuitant/insured dies. 

Beneficiary: The person(s) named on the segregated fund contract by the contract owner to receive the death benefit when the annuitant/insured passes away. Your beneficiary can be anyone – a family member, a friend, or a charity. 

Insurance company: This is the company that you enter into a contract with and that backs the guarantees of the provisions in your contract. 

Advisor: Your key contact! Advisors who are licensed to sell insurance (including segregated funds) can help you determine the segregated fund contract that’s suitable for your needs. An advisor can also help you decide on specific funds that are available in the contract.

The appeal of segregated fund contracts depends on a few key factors, such as time horizons, fees and estate benefits that differ from typical mutual funds or exchange traded funds. But what makes them unique could be what makes them the right type of investment for you. Speak with your advisor to see if a segregated fund contract is suitable for your investment strategy or needs.

Segregated fund products at a glance  They perform much like mutual funds, wherein they’re a collection of diversified portfolios of stocks and other assets, but in addition to this, they’re a type of insurance product that offers additional benefits and some potential protections of your credit and principal investment.  They typically cost more than mutual funds, due to the added insurance component and the guaranteed protection of your principal.  You can choose a contract that protects 75 per cent or 100 per cent of your capital. The higher the guarantee percentage, the higher the cost.  Only insurance advisors, or those licensed to sell investments and insurance (and some online brokers) can sell segregated funds, which lowers their availability compared to mutual funds.  Recognized as a type of insurance contract, they remain within the jurisdiction of insurance regulators rather than securities regulators.

Small business safeguards: Understanding the importance of having a creditor protection strategy

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The Canadian economy is fuelled by the enthusiastic hard work of the small business owner. The Business Development Bank of Canada estimates that 70 per cent of the country’s private labour force is employed by small businesses, and the diversity is amazing – from make-your-own jewellery storefronts to microbrew pubs to the dental clinic in your neighbourhood. 

A small business venture may be a deeply personal dream come true, but even dreams don’t always work out. Surprisingly, many owners, officers and directors don’t realize their personal assets can be at risk of creditor claims in the event that something goes wrong with the business. The coronavirus pandemic is certainly a challenging time, and it points to the importance of having a solid creditor protection strategy to help minimize the impact in the event your venture doesn’t continue to flourish.

Make your business creditor-proof

The best time to implement a creditor-proofing strategy is either when the business is starting up or while it is healthy and not facing creditor claims. It’s almost impossible to establish a creditor protection plan when a business is in trouble. Tax and legal professionals, with the assistance of your advisor, can help you in developing a plan that covers all the bases. The following tips can help to serve as a guide in the process:

  1. Think about incorporating your business if it is either large or at risk of litigation. Professional practices should carefully consider this option.
  2. Not all debt is created equal. Always pay your statutory debt on time; directors and officers can be personally liable for these debts (see A note on liability below).
  3. Ensure sufficient personal liability coverage (e.g., director’s home and auto coverage). In the event of a serious accident, your personal assets (e.g., home, car, boat) could be seized to pay any shortfall in insurance coverage.
  4. Ensure that your spouse is outside the reach of creditors in the event that anything goes wrong in the business. If your spouse is a director or officer, they can carry liability for debts. If your spouse is an employee, or not involved in the business, you will have much more flexibility in your creditor protection plan.
  5. Make use of spousal Registered Retirement Savings Plans (RRSPs) to transfer wealth to a spouse – and away from creditor risk.
  6. If your spouse is not involved in the business, consider moving your personal assets – such as your house and your savings – to your spouse’s name. You can transfer home ownership to your spouse tax-free.
  7. Hold life insurance contracts personally (not corporately). Name a “family class” beneficiary on life insurance contracts and list yourself as both the owner and the annuitant/insured. Doing so may prevent creditors from seizing the assets, as well as ensuring the assets transfer immediately to your beneficiary at the time of your death. Remember that if the death benefit is payable to your estate, it can get tied up in probate and may be subject to fees and seizure by creditors of your estate.
  8. Place your savings into investment products sold by insurance companies. A segregated fund contract or a Guaranteed Interest Contract (GIC) product purchased through an insurance company offers potential creditor protection when you name a “family class” or irrevocable beneficiary.

Hoping for the best while preparing for the worst is just good planning if you are a business owner. You are investing a great deal financially, emotionally and physically to create a successful venture. Your advisor can help you to create a plan that will protect your hard-earned assets from creditors.

What is a “family class” beneficiary?
A family class designation is a spouse, child, grandchild or parent of the annuitant in all provinces except Quebec. In Quebec, a family class designation includes the spouse, ascendants and descendants of the policy owner.

A note on liability
Business owners, officers and directors can be personally liable for:Any debts they have given a personal guaranteeAny statutory debts, such as wages and vacation payAny source deductions and commodity taxesHealth and safety violations, including environmental damage 

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