You may have heard the term “segregated fund” in a planning conversation and wondered how it differs from a traditional mutual fund.

On the surface, they can look similar. Both invest in diversified portfolios of equities and bonds. Both participate in market growth.

The difference is structural.

Segregated funds are investment contracts issued by life insurance companies. Because they are insurance contracts rather than traditional investment accounts, they can include features that mutual funds and ETFs do not.

Let’s look at what that means.

What Is a Segregated Fund?

A segregated fund is a pool of investments offered through an insurance company. Investors purchase units within an insurance contract, not units of a mutual fund trust. This insurance structure allows certain contractual guarantees and estate features to be built in.

Key Features of Segregated Funds

1. Maturity and Death Benefit Guarantees

Most segregated fund contracts offer guarantees of 75 percent or 100 percent of net deposits, subject to contract terms.

• The maturity guarantee typically applies at a specified maturity date, often 10 years from each deposit.
• The death benefit guarantee applies upon death of the annuitant.
• Withdrawals generally reduce the guaranteed amount proportionally.
• Some contracts include optional reset features that can increase the guaranteed base.

If market values decline and the contract is held to maturity, or the annuitant passes away, the insurer may top up the value to the guaranteed amount. Guarantees apply at specific contractual events, not daily.

2. Estate Planning Features

When a valid beneficiary is designated, segregated fund proceeds may pass directly to that beneficiary outside of the estate, subject to provincial legislation.

This can:

• Reduce or avoid probate fees in certain provinces
• Maintain privacy compared to a probated will
• Allow for faster distribution of proceeds

Rules vary by province, and beneficiary designations must be properly structured.

3. Potential Creditor Protection

Under certain circumstances, segregated funds may offer creditor protection when a qualified family class beneficiary is named, such as a spouse, child, grandchild, or parent.

Protection is not absolute. It depends on:

• Proper contract structure
• Timing and intent
• Applicable provincial and federal laws

This feature can be particularly relevant for business owners and incorporated professionals.

4. Market Participation With Downside Guardrails

Segregated funds participate in market growth, and like mutual funds, earnings are taxed annually based on distributions allocated within the contract.

The insurance guarantees provide a contractual downside floor at maturity or death, not ongoing protection against daily market fluctuations.

Trade-Offs to Consider

Segregated funds typically carry higher management expense ratios than comparable mutual funds or ETFs. The insurance guarantees and estate features contribute to these costs.

They also include contractual maturity periods that need to be understood before investing.

They are not inherently better or worse than other investment options. They are designed to solve specific planning needs.

When Might Segregated Funds Make Sense?

They may be appropriate for:

• Investors nearing retirement who value a maturity or death benefit guarantee
• Individuals focused on estate efficiency and smoother wealth transfer
• Business owners seeking potential creditor protection
• Clients who prioritize contractual guarantees alongside market exposure

They may be less appropriate for:

• Younger investors with long time horizons and high risk tolerance
• Fee-sensitive investors who do not require insurance features
• Investors comfortable managing estate planning through other structures

The Bottom Line

Segregated funds are insurance contracts with investment components. In the right circumstances, they can provide estate efficiency, contractual guarantees, and potential creditor considerations.

In other situations, they may simply add cost without adding meaningful benefit. The key question is not whether segregated funds are good or bad.

It is whether their specific features align with the planning objectives at hand.

Source: www.canada.ca