Segregated Funds: Investing With A Safety Net
Standard Life recently made the decision to focus primarily on investment products and their new Segregated Fund product presents some interesting opportunities for people looking to get more stability in their investment portfolios.
100% Maturity and Death Benefit Guarantee
At a time when most companies are reducing their guarantees to 75%, Standard Life offers 100% guarantees for both maturity value and death benefit. This means that at the maturity date, the value of the investment will be the greater of the market value or 100% of the sum of deposits less any withdrawals taken. In other words, at maturity (minimum 15 years), your worst case scenario is receiving full value for all of your deposits.
Similarly, the 100% death benefit guarantee provides that at death your beneficiary will receive the greater of the market value of your segregated fund or the sum of all your deposits less any withdrawals taken.
Reset Feature for Maturity and Death Benefit Guarantee
With this feature you have the ability to reset the maturity guarantee value twice per year. Accordingly, you can lock in your investment gains at maturity. With each reset you also have the option of designating a new maturity date.
For the death benefit guarantee the values are automatically reset every three years thereby locking in your investment gains at death.
Resets can have significant value in a volatile market. For example, in 1999 one client had invested $500,000 in a segregated fund and selected a technology fund as the investment choice. The technology boom saw that investment soon grow to $850,000 and the client wisely exercised his reset option. Shortly afterward, the dot.com bubble burst and the investment value fell from $850,000 to $300,000 and never recovered beyond that. This same bubble burst devastated many investors while this client was able to recover the full $850,000 at his maturity date in 2009.
Designation of Beneficiaries enables protection
One fact about segregated funds that is often overlooked is that as a product of a life insurance company, you can name a beneficiary for the proceeds at your death. This creates the potential that your segregated fund investment may be free from the claims of creditors or potential litigants.
No Charge Withdrawals
Almost all segregated fund products allow for the annual withdrawal of up to 10% of the total value in your fund without incurring charges. After the conclusion of the deferred sales charge period (usually seven years) there is no charge for any amount withdrawn (although taxes may be owed).
The following scenarios show how beneficial these features can be in creative planning using segregated funds.
Scenario #1 – Investing Using a Balanced Portfolio
We are experiencing very volatile investment markets which have created a significant amount of stress and emotional turmoil especially amongst older investors. The stakes go up the closer you get to retirement so many investors are have forsaken the potential of higher returns for a significant portion of their portfolio. While this does reduce risk, it definitely guarantees lower returns. For example, Government of Canada bond yields as of the end of March, 2012 were 1.57% for a five year bond and 2.11% for ten years. At the same time, the long term real return bond was 0.51%. By using segregated funds and taking advantage of the 100% Maturity Guarantee and reset options, one could achieve balance in their portfolio without necessarily locking in low yields. In fact, the segregated fund could perform similar to a participating bond in this situation.
For example, suppose an investor had a portfolio worth $500,000. A decision is made to keep 50% of that portfolio in equities while the balance of $250,000 is to be invested in a low or no risk investment. In this situation, you could invest the $250,000 into one of the balanced or more conservative investment options in a segregated fund. For the purposes of this example we have specifically utilized Standard Life’s Ideal Signature Series. The 100% maturity option is selected guaranteeing that your investment will be worth a minimum of $250,000 at maturity. Suppose your investment growth over the next year is 10% and is now worth $275,000. You could now reset your maturity guarantee, designate a new maturity date and then withdraw your gain of $25,000. You still have an investment worth $250,000 at maturity but now you have taken out your profit of $25,000. Maintaining your initial investment at the same time as receiving cash flow in the form of a partial withdrawal is very similar to the results that might be achieved through investment in a participating bond.
Scenario #2 – Estate Conservation for Mature Investors
Let’s assume that you are a mature investor who is trying to preserve your investment portfolio for the next generation, but you are not satisfied with receiving a low interest return taxed at a high rate as would be the case if you were using fixed income or bonds. The 100% death benefit guarantee contained in the segregated fund means that you can remain invested in a balanced equity portfolio while not risking the estate value of your investment portfolio. Regardless of what happens in the market, your investment fund is totally guaranteed at your death. The 100% death benefit guarantee is applicable to contracts purchased before age 80. For contracts purchased after age 80 the guarantee is 75%. However, an important feature of Standard Life’s product is that the guarantee is based on the contract’s initial deposit date. This means is that if you were 79 and deposited only $1,000 into a non-registered account, all future deposits, regardless of how much they total, would be 100% guaranteed at death. For example, let us assume you deposit $1,000 into a Standard Life Signature Series segregated fund at age 79. After age 79 you could deposit any amount and the total amount invested would be guaranteed 100% at your death. Also, should there be a favourable market, in all likelihood; there will be more funds available for the next generation than might otherwise be available in a fixed term investment. In addition, the income tax paid on the Segregated Fund should be significantly less than that paid on a fixed term investment or bonds.
By naming a beneficiary, upon your death all your segregated fund investments will flow to your beneficiary without any probate fees, administrative costs or risk of Wills Variation Act litigation.
Scenario #3 – Capital Protection
As mentioned, the maturity and death benefit guarantee does protect capital by returning the full value of the investment at maturity. However, market downturn is not the only risk to which capital can be exposed. For many professionals or business people there are situations which may involve litigation either by creditors or other parties who feel they have a claim against your personal and business assets. By appointing a preferred beneficiary, this risk is potentially eliminated.
Scenario #4 – Complicated Estate Protection
For domestic situations involving previous marriages and the desire to protect capital for present or previous family members the beneficiary designation could be made irrevocably. The irrevocable beneficiary designation confers rights and protection on the beneficiary they would have not enjoyed by being named simply as a primary beneficiary.
The Ideal Signature Series of Segregated Funds by Standard Life offers features not available with most other providers and they do so at a very reasonable cost. In fact of the 49 funds available with Standard Life almost half of them come with management fees of less than 3%. In a time when most companies have eliminated the 100% maturity guarantees or increased the management fees prohibitively, Standard Life offers investors the opportunity for stress free investing.