Segregated funds have been increasingly talked about by Canadians looking for investment growth opportunities, estate planning advantages, and some form of protection against the possibility of loss due to market fluctuation. Segregated funds are certainly not new; however, they have become increasingly important as more and more people seek wealth protection strategies that provide growth along with safety. It is reported by the Canadian Life and Health Insurance Association that Canada’s life and health insurers paid a record $143.3 billion in insurance benefits and retirement solutions in 2024, of which $71.4 billion represented retirement benefits in annuities.
Nonetheless, most of the investors seem uncertain about one fundamental aspect related to segregated funds: What exactly are segregated funds? The definition of segregated funds can be provided as follows: segregated funds are investment funds sold through the services of Life Insurance companies.
They are sometimes also called a guaranteed investment fund, although the word “guaranteed” must be understood carefully. Segregated funds do not guarantee that the market value will always grow. The guarantee usually applies at death or at the maturity date of the contract, and it is often based on a percentage of deposits, such as 75% or 100%, depending on the product.
What Are Segregated Funds?
Segregated Funds refer to an investment vehicle that is held within an insurance contract. Similar to mutual funds, these funds collect funds from several investors and invest the same in stocks, bonds, balanced securities or income-generating investments. The funds are professionally managed according to the goals of the investment fund.
The major difference lies in the issuer of the fund. While the ordinary mutual funds are issued by mutual fund firms, segregated funds are issued by Life Insurance companies. This creates several characteristics in segregated funds that cannot be offered in regular mutual funds, such as maturity guarantees, death benefit guarantees, provision for naming of beneficiaries, probate advantages and even creditor protection.
The term “segregated” refers to the fact that the investments are segregated from the assets of the issuing company. This does not eliminate investment risks, though.
How Do Segregated Funds Work?
When an investor puts their money into segregated funds, the investor’s money is put into a particular fund that will be chosen from the options provided by the insurer. This fund can be a conservative fund, balanced fund, equity fund, income fund or target date fund, depending on the preference of the investor.
The market value of the segregated fund is determined by the performance of the fund. In case the segregated fund consists of equities, its value can fall because of market movements. In case the segregated fund contains fixed income, its performance will depend on the bond markets and interest rates. Therefore, despite being investment funds with market risk, segregated funds also have insurance features.
It is important to mention that the insurance features come into play at certain moments, such as the end of the contract period or the death of the insured person. When at any moment, the market value of the segregated fund is less than the guaranteed amount, then the insurer can increase the market value according to the guaranteed amount in the contract.
What Is A Guaranteed Investment Fund?
A guaranteed investment fund is another term that is synonymous with segregated funds, and it means the guarantee component of the insurance policy. This guarantees 75 percent or 100 percent of the deposits upon maturity or upon the death of the individual.
It does not mean that the account will not experience losses each year. It will. There is a difference between the guarantee of a segregated fund, a GIC, and the daily principal guarantee. Segregated funds are still susceptible to market fluctuations, and the guarantee is contingent on the contract and may apply only after a certain period or the death of the policyholder.
This is the reason why investors need to understand the information folder and the terms of the contract.
Segregated Fund Benefits
The primary advantage of segregated funds lies in their ability to provide both investment opportunities and insurance-related protection features. Segregated funds may help with planning retirement and estate, as well as wealth protection.
The most important benefit provided by segregated funds is the death benefit guarantee. In case the investor dies and there is a decline in market value, the designated beneficiary may get either the market value or the guaranteed amount, according to the contract. It can help those who would like to provide their family with some money but would still have some investments.
One of the other benefits is the maturity guarantee. It can protect either partial or whole deposits at the date of maturity of the contract. The periods of maturity are usually quite long, even 10 years or more.
Segregated funds can also be useful for estate planning purposes, as the investor can designate the beneficiary directly in the contract. Under certain conditions, this could enable the proceeds to be paid to the beneficiary without going through the probate process, depending upon the province and specific circumstances.
The possibility of protection from creditors is one of the reasons why certain businesspeople opt for segregated funds. It is important to understand that this is not always the case; in order for this to be true, it would depend on various aspects, including who the beneficiary is, when it was done, etc.
Segregated Fund Risks
Segregated funds also carry risks and have certain limitations. They are not for everyone, and they must not be offered as completely risk-free investments.
The first risk is market risk. The value of the segregated fund can go up or down according to its investments. Neither 75% nor 100% guaranteed at maturity or death means that there will be no losses prior to that time.
The second risk is cost. Segregated funds tend to cost more than comparable mutual funds due to insurance features. This means that they can lower the long-run returns on investment, especially in cases when investors do not need any guarantees or estate planning services provided by segregated funds.
The third risk is related to a misunderstanding of the guarantee. The guarantee applies at death or at maturity, but not necessarily at any other time. When an investor withdraws the money earlier from the segregated fund during the market downturn, he or she will get the market value and not a guaranteed one.
Finally, liquidity is important to consider. Depending on the type of contract, some products can have penalties or restrictions when withdrawn.
Segregated Funds Vs Mutual Funds
The comparison between segregated funds vs mutual funds is important because both products can hold similar investments, but they are structured differently.
| Feature | Segregated Funds | Mutual Funds |
| Product Type | Insurance Contract | Investment Fund |
| Provider | Life Insurance Company | Investment Fund Company |
| Market Risk | Yes | Yes |
| Death Benefit Guarantee | Usually Available | Not Available |
| Maturity Guarantee | Usually Available | Not Available |
| Named Beneficiary | Usually Available | Usually Not The Same Way Outside Registered Plans |
| Probate Bypass Potential | Possible In Many Cases | Generally Not The Same |
| Potential Creditor Protection | Possible In Certain Situations | Generally No |
| Fees | Often Higher | Often Lower |
Mutual funds may be better for investors who want lower fees, simple liquidity, and direct market exposure without insurance features. Segregated funds may be more suitable for investors who value guarantees, estate planning, beneficiary protection, and certain wealth transfer features.
The better choice depends on the person’s age, investment timeline, risk tolerance, tax situation, estate goals, and need for protection.
Segregated Funds For Retirement Income
Segregated funds for the generation of retirement income may prove beneficial to people who seek market exposure along with some contract-related protection. Income portfolio, guaranteed withdrawal, and lifetime income options may be available among other features that may be offered by specific products.
The reasons for a retiree being interested in a segregated fund are both emotional and financial. The desire to receive growth opportunities and the fear of a market crash on the verge of or during retirement are common among people. Although a segregated fund will not eliminate this risk, guarantees of maturity and death benefit may help lower it to some extent if used correctly.
However, it does not necessarily mean that all retirees should consider buying segregated funds. People with a shorter horizon, high risk aversion, and the need for complete liquidity cannot benefit from such an investment option. It is also necessary for a retiree who decides to use segregated funds to be aware of costs, withdrawal options, dates of guarantees, and the effects of withdrawal on guarantees.
How Are Segregated Funds Taxed In Canada?
The taxation of segregated funds in Canada depends on whether the investment is held in a registered or non-registered account.
If segregated funds are held in a registered account, such as an RRSP, RRIF, TFSA or any other registered plan, the usual taxation rules for that registered account will apply. Withdrawals from RRSP and RRIF plans will be considered income, and income from TFSA will be non-taxable under the conditions provided.
In a non-registered account, segregation funds will be able to allocate taxable income, capital gain, dividends, or foreign income to the investors. It can be noticed that the method of reporting taxes for segregated funds differs from the method used in the case of mutual funds, since segregated funds have their roots in insurance contracts and segregated fund trusts.
It is crucial for people who would like to know how segregated funds are taxed in Canada. In order to determine whether segregated funds are taxable or not, many factors must be considered, including account type, segregation funds activities, income allocation, withdrawals, and personal tax position of the investor.
What Happens To Segregated Funds At Death?
What happens to segregated funds in the case of death is perhaps the most crucial factor in people’s choice of segregated funds. In case a beneficiary is appointed, the death benefit may be paid out to him or her. This helps to save time and effort because the payment may not have to go through probate, although this depends on the province and circumstances.
Death benefit guarantee can also apply. In case the market value is less than the amount of the guaranteed death benefit, then the insurer may be required to pay the guaranteed sum according to the terms of the contract. However, in case the market value exceeds the amount of the guaranteed sum, then the market value is paid.
Segregated funds offer an opportunity for growth while providing an estate planning advantage. But the beneficiaries should be designated correctly.
Who Should Invest In Segregated Funds?
Segregated funds might be appropriate for those who wish to have both investment opportunities and estate planning and other protective measures. Segregated funds could be a good choice for retirees, pre-retirees, business owners, professionals, individuals having problems with their estate transfer, and people wanting to have named beneficiaries.
Furthermore, segregated funds could attract people concerned about transferring their money to family members after the fall of the markets. The death benefit guarantee could help secure a certain share of value in case of poor market conditions for the sake of beneficiaries.
At the same time, segregated funds might not be a good fit for those looking for investments with the lowest fees, active trading, short-term investments, and market exposure. Younger people with a long-term horizon and no estate planning needs could find mutual funds and exchange-traded funds cheaper.
In most cases, segregated funds do not have to represent an investor’s whole portfolio. On the contrary, such funds should be chosen only for some share of one’s retirement savings, estate planning capital, and wealth transfer planning.
Wealth Protection Strategies With Segregated Funds
Segregated funds are a part of overall wealth protection programs. They can help in protecting retirement investments against risk, beneficiary planning, and estate settlement delays.
A retired individual may use segregated funds as a portion of his/her non-registered investments to establish a clear beneficiary transfer. An entrepreneur can look at segregated funds based on the fact that there could be some protection against creditors’ claims, depending on legal requirements. A prudent investor may invest in segregated funds due to the maturity and death guarantees provided by segregated funds during volatile periods.
It all boils down to using segregated funds for the right reasons. Purchasing segregated funds simply due to their “guaranteed” nature could result in frustration. Investing in segregated funds based on the fact that the investor requires certain insurance-related features is probably a better option.
Life Insurance Investments And Segregated Funds
Segregated funds tend to be classified as Life Insurance investments because they are provided by Life Insurance firms and possess insurance contract characteristics. However, they are not similar to any Life Insurance products like term life, whole life, and universal Life Insurance since they have no death benefits. They just possess death benefit features.
They differ from typical investment accounts due to the presence of insurance features that may facilitate beneficiary designation, death benefit guarantees, and estate transfer. On the other hand, investments will always rely on market returns. In such a way, when people try to choose between Life Insurance investment products, they need to understand their purposes.
Life Insurance is designed to protect individuals from the consequences of death. Meanwhile, segregated funds concentrate on investments with death benefit guarantees and estate components. They may coexist, yet they are different types of products.
Common Mistakes To Avoid With Segregated Funds
Segregated funds can support wealth protection strategies, but they work best when investors understand the contract details before investing.
- Assuming Segregated Funds Cannot Lose Money:
Segregated funds can lose market value because they are still linked to investments such as stocks, bonds, or balanced portfolios. The guarantee is tied to the contract terms, usually at maturity or death, not to the daily account value. If an investor withdraws early during a market decline, they may receive the current market value rather than the guaranteed amount. - Ignoring The Cost Of Guarantees:
Segregated funds often have higher fees than similar mutual funds because they include insurance features such as maturity guarantees, death benefit guarantees, and beneficiary options. These costs may be worthwhile when the investor needs those benefits, but they can reduce long-term returns when the guarantees or estate planning features are not needed. - Not Checking The Maturity Date:
The maturity guarantee may apply only after a specific period, often many years later. Investors should be comfortable staying invested long enough to benefit from the guarantee. Choosing a segregated fund without understanding the maturity date can lead to disappointment if money is needed earlier. - Naming Beneficiaries Without Proper Planning:
Beneficiary choices should match the investor’s estate goals, family situation, tax planning, and legal documents. A poorly planned beneficiary designation can create confusion, delays, disputes, or unintended results after death.
Are Segregated Funds Worth It?
Segregated funds may be worthwhile in cases where the investor finds their insurance components valuable enough to make up for the price difference. This could be relevant in scenarios involving retirement income planning, wealth preservation, estate planning, and instances where there are guarantees.
Segregated funds may not be worthwhile if the investor does not need the insurance components. In such cases, other investments like mutual funds, ETFs, GICs, and other investment instruments may suit the needs of the investor.
The question “Are segregated funds good?” may not necessarily address the issues. It should be more along the lines of, “Do the advantages address an issue in my investment plan?”
Final Thoughts
Segregated funds can work well for Canadians who need investments with growth and some insurance aspects. These kinds of funds may help you plan your future income, make estate plans, beneficiary protection, and wealth protection plans. On the other hand, these funds are also exposed to market risk, involve more fees, and demand a detailed understanding of your contract.
If you compare segregated funds against mutual funds, you need to decide what you need. If you need guarantees, beneficiary planning, and some estate benefits, you may consider using segregated funds. In case you need inexpensive investments without any insurance aspect, there are other solutions for you.
Learn More: Life Insurance Riders: Types, Benefits & Working