Are Segregated Funds Right for Your Investment Portfolio?
If you're concerned about preserving wealth for the next generation, or just want to manage investment risk, there may be a place in your portfolio for segregated funds.
In many ways, segregated funds are similar to conventional mutual funds. But there is a key distinction; segregated funds guarantee that you'll get part or all of your original capital back after a number of years. They offer other features, such as estate planning advantages, a death benefit guarantee and potential creditor protection.
Segregated funds are a way to make sure you get at least part of your original investment back, regardless of what happens with financial markets. This makes them excellent vehicles for retirement investments.
Segregated funds are made possible by combining the features of mutual funds with insurance protection. These funds get their name from the fact that each fund represents a pool of assets that are 'segregated; or held separately from, an insurance company's other assets.
When you die, your beneficiaries receive the greater of the current market value of the investment or between 75%and 100% of the invested amount (less withdrawals). If you designate a beneficiary outside of your estate, your investment will be free of probate and executor fees upon your death. Beneficiaries receive proceeds quickly and privately.
A segregated fund is really a variable annuity in the form of a contract with a specified maturity date-typically10 years from the date of purchase. At maturity, the investor is guaranteed to receive a portion or all of the initial investment. Most funds guarantee the return of 75% of the original investment when they mature, although some offer 100% guarantees.
When you invest in a segregated fund, you purchase an individual variable insurance contract. Premiums are paid to the insurer, based on the value of the fund. When the investment is redeemed, the insurance company returns premiums, based on the current value of the units in the fund.
Like conventional mutual funds, segregated funds can be easily purchased and redeemed, offer the potential of capital gains, and a large selection of funds is available through mutual fund organizations that have teamed up with life insurers to sell these investments.
Segregated funds cover the same asset classes as mutual funds, including Canadian equities, U.S. equities, international stocks, bonds and money markets. Some can be purchased without sales charges, ("no-load" funds), while others incur charges ("loads"). Segregated funds are available in both Registered and Non-registered plans.
The demographics of the Canadian population is changing, with a growing number of baby boomers heading toward retirement. Insurance companies have started to develop new segregated fund solutions to match the needs of these Canadians. Living longer and concern about having enough income during the retirement phase of your life can pose some challenges. Income solutions such as Guaranteed Withdrawal Benefit options are starting to emerge to help Canadians better manage their income during retirement.
However, there is a price to pay for the features of segregated funds. These funds usually have higher management fees than similar mutual funds to help cover capital guarantees and the insurance portion of the investment.
Pay down your mortgage or contribute to an RRSP?
Is it better to pay down your mortgage or contribute to an RRSP?
When you contribute to an RRSP, you get an immediate income tax savings. The higher your marginal tax rate, the more you save. On the other hand, when mortgage rates are high, or significantly higher than the returns you could obtain within your RRSP, paying down your mortgage may make sense.
But why not do both?
Let's assume you have $5,000 in savings. The principal on your mortgage is $100,000 amortized over 25 years. Your mortgage rate is 6%, monthly payments are $640 and your marginal tax rate is 40%. If you make no additional mortgage payments, you will pay $91,942 in interest over 25 years.
Scenario 1: You invest the $5,000 in an RRSP and receive a $2,000 tax refund, which you use to reduce your mortgage principal to $98,000, amortization to 24 years and total interest to $85,911 - a savings of $6,031. Assuming a 5% return, your RRSP contribution will grow to $16,931 over the amortization period, for a combined savings of $22,962.
Scenario 2: You put the entire $5,000 toward your mortgage, reducing your amortization to 23 years and total interest to $77,724 - a savings of $14,218.
By contributing to your RRSP and applying the refund to your mortgage you saved an additional $8,744. You also diversified your investments, reduced risk and increased your earning potential.
This is just an example - your results may vary depending on your age, marginal tax rate, investment returns, time horizon and mortgage rate. But it shows you can succeed by both contributing to your RRSP and paying down your mortgage. |
