Segregated Fund Benefits

Steve from Tecumseh dropped by with a question on guaranteed investment funds, also known as segregated funds. Steve wondered why so many retirees look at segregated funds for investing. He brought in a brochure that outlined some of  thebenefits including guarantee of  principal at deposit maturity (in this case 10 years) and 100% upon death; resetting of  the guarantee when the market value of  the investment fluctuates; and an immediate transfer of  funds upon death without probate and/or estate fees. Reading over the brochure more carefully revealed all of the details and options available for Steve; for example, most of his favorite mutual funds are offered as segregated funds. He can put money into a variety of different investments and still have the same manager and style he has now. He was thinking of switching from mutual funds to segregated funds to simplify his estate. While some of his funds are in RRIFs and some are outside his registered plans, the switch could have some tax implications. Inside his RRIF, he can simply transfer from one plan to another just like a RRSP tax-freetransfer.

The final question Steve had was that, if the risks are the same because the investments are the same, why do most retirees do not take advantage of these options and guarantees. My answer was simple–

not everyone has heard of segregated funds.

I wrote an article introducing segregated funds. After receiving calls asking me to discuss them in more detail, I thought I would write out a list of benefits and features. While each investment or insurance company has its own features, segregated funds in general are comprised of a pool of investments, professionally managed by different investment managers and administered by life insurance companies. The life insurance companies add the benefits that can make these investments more attractive than mutual funds. Here is the list:

-100% of your investment guaranteed upon death to your beneficiaries, no loss of capital. Not all plans have this option, so check with your insurance company.

-A maturity guarantee of 100% of your principal investment regardless of market conditions.

-Maturity guarantee reset and death benefit guarantee on a higher amount. (While your investment grows, so does your guarantee upon maturity and to your beneficiaries, thus locking in future profits for

you and your family.)

-Creditor protection for professionals and small-business owners. (Under the Insurance Act, you have the potential of protecting those investments from creditors. A professional such as accountant,dentist, doctor, or small-business owner may benefit.)

-Estate planning benefits, such as no probate, no public record of probate, and 100% of the investment passing directly to your beneficiaries instead of through your estate. (I could list a subset of advantagesunder this benefit.)

-Access to most of the top-performing investment managers available to build a truly diversified and well-managed portfolio. If you want to add contractual written guarantees to your investments, then segregated funds may be worth a closer look.

GIA, GIC, and Other Acronyms

Every day we are exposed to jargon. In the financial industry, there can be a lot of terms. I have come to an understanding that people want feelings and emotions, not words. People who are retired and concerned about protecting their income, about health and medical costs, about living alone or in a care facility, and/or about running out of money.

In financial terms, they may look at insurance plans such as long-term care, critical-illness or disability insurance. We (financial professionals) define things in our own language. We define people who want their money to grow as investors looking for growth, higher-risk investors, equity investors, or holders of common stock portfolios. We define retirees seeking a monthly cash flow to live comfortably without losing any capital as income investors. They would invest into segregated funds, GIAs (guaranteed term deposits issued through life insurance companies) GICs, conservative portfolios, income funds, real return bonds, etc. Families worried about protecting income would look at life insurance, disability or income-replacement plans, and group insurance benefits.

Retirees talk about income; the financial industry talks about systematic withdrawal programs, redemption plans, return of capital, dividends, interest, and capital gains income. Investors talk about rate of return and expectations; the financial industry shows statements and numbers and projections, past and future.

Ask me what a back-to-back annuity is, and I’ll ask you if you want guaranteed income and whether you want to have the same amount paid out to your children when you die.

One term you will need to know is GMWB, discussed on the next few pages.

You want a simple financial plan to get you to where you are going. The financial industry throws you gobs of paper, plans, brochures, projections, and statements. Keep it simple; know what you want; know your financial values (e.g., enough money to spend monthly and extra money annually in your

retirement years to live comfortably); then create a plan that you understand and can follow. This will simplify the jargon.

Looking for Guarantees?

We know that in life there are two guarantees, death and taxes. We can go out and buy life insurance to insure ourselves for our loved ones in case of death, and the benefit is tax-free. But how can we invest our money and accomplish the same benefits?  Look into segregated funds. They allow you to name a

 beneficiary and some plans can guarantee 100% of your investment to your estate upon death regardless of market value. This can give your family added peace of mind in a world of volatility. You can even add on a benefit called GMWB, or guaranteed minimum withdrawal benefit, and guarantee your income for life at a certain age. For example, Edna from Windsor, who is 65, invested $100,000 into segregated

funds and $100,000 into a GIC, naming her two children asbeneficiaries–this will bypass probate and simplify her estate. The money is 100% guaranteed upon death regardless of marketvalue, and Edna will receive a minimum of 5% income guaranteed for her lifetime. As an added bonus the income paid

to her is not all interest income since the GMWB generates tax-efficient income, making the plan more attractive (and Edna pays less tax).

Now Edna has some guarantees. Upon her death the money is 100% guaranteed to her family for thefull amount without probate fees, her income is guaranteed for life at 5%, and she has a guaranteed interest rate on the GIC.

 GMWB

In the next few years, every Canadian investor will know this acronym. If you are retiring soon or are already retired, you should know that GMWB stands for guaranteed minimum withdrawal benefit. This will be the largest change in retirement planning I have seen in seventeen years.

We know that a GIC can add safety and security in retirement; however, rates change. GMWB plans can offer a predictable income guaranteed not to decrease for life. GMWB plans are offered by Canadian life insurance companies and, as the name suggests, offer guaranteed minimum withdrawal benefits, usually at 5% to 6% (depending on your age at the time) for the rest of your life. The plan gives you sustainable, guaranteed income that is designed to resemble a pension plan. The income has the potential to increase to keep pace with inflation and, unlike pension plans, investors have access to their savings at any time. (However, this can change the guarantees.) The investor can have the potential of market gains and yet has the guaranteed cash flow no matter what the market losses are.

GMWB plans address two unique retirement risks. First, if you are retired and worried about outliving your savings, a properly set up GMWB can guarantee your income for life. Second, you run the risk of depleting your savings or capital due to bad investments, poor investment decisions, or taking on too much risk. A GMWB plan tackles these risks in ways that traditional investments fail–to guarantee investors their future. The GMWBcarries a minimal cost compared to risking a lot of money. The additional benefits of GMWB plans are that they can be set up in nonregistered investment accounts and the income is tax-efficient and guaranteed for life. GMWB plans are only offered through life insurance companies, which means you must name a beneficiary; this means it will bypass probate fees and ensure an easy transition to your estate. Currently there are six Canadian insurance companies offering GMWB plans–all with guarantees for your retirement.

GMWB versus GIC

Brett from Kingsville dropped by my office and asked me a great question. What is the difference between GMWBs and GICs? Brett, aged 65, recently retired and has his nest egg to invest for retirement income. I first explained that GMWB plans use a wide variety of segregatedfund investments inside the plans. Insurance companies can add contractual guarantees like an annuity or pension plan on top of your investments and charge a fee to give you additional guarantees. GICs, however, cannot guarantee income for life or offer a 100% death benefit like some GMWB plans. GMWBs have the added benefit of bypassing probate and simplifying one’s estate when a beneficiary is named. GICs guarantee the capital and interest for a specified period of time, usually from one to five years. “Brett,” I said, “if  your goal is to plan for a secure retirement with predictable and sustainable income without worrying about the value of  your investments, it may be worthwhile to look into GMWBs as part of  your overall plan.”

GMWBs are flexible and give you access to your savings, but if  you need additional income or capital down the road, you usually take that money from other investments since taking it from GMWBs could affect your guarantees. While GICs are used for accumulating and preserving assets, GMWBs are designed for investors turning their investments into income in retirement and accumulating before retirement.

GICs can pay income monthly (sometimes at a lower rate) for the length of the term. GMWBs pay income guaranteed for life depending on your age. With GICs you know that the capital stays the same and that your risk is low; with GMWBs the capital can fluctuate, and you can choose different levels of risk with the money invested. While each one has guarantees, your choice depends on what type of guaranteeyou want. That is the better question. Ask your financial professional about the type of guarantees you are looking for in your investments and retirement.