The Case for Segregated Funds: Faster Payouts, Privacy, and Lower Costs for Beneficiaries

When a loved one passes away, the financial implications for the family left behind can be significant. Many families expect a timely distribution of assets, yet the reality of estate settlement can be complex and time-consuming. One of the most efficient ways to ensure that assets are distributed quickly, with enhanced privacy, and minimal legal fees is through Segregated Funds (aka Seg Funds).

In this article, we’ll explore why Segregated Funds can be a superior choice for estate planning, focusing on the time it takes for beneficiaries to receive their funds, the privacy these funds offer, and the potential cost savings compared to other investment vehicles such as Mutual Funds or standard investment accounts.

Probate vs. Segregated Fund Payouts

One of the most significant differences between Segregated Funds and other forms of investment is how quickly the funds are disbursed to beneficiaries.

Segregated Fund payouts are typically processed in 5 to 10 business days after all necessary documents are received by the insurer. This quick turnaround can provide families with financial support in a matter of days, which can be critical for covering immediate expenses or addressing other pressing financial needs.

In contrast, investments that are part of an estate and go through probate require significantly more time. The probate process, especially when waiting for a Clearance Certificate from the Canada Revenue Agency (CRA), can take an average of 4 to 6 months, and in more complex cases, as long as 12 to 24 months. During this time, the funds remain inaccessible to beneficiaries, potentially creating financial strain during an already difficult period.

Staying Invested in Equities with Confidence, Even as You Age

As Canadians approach retirement or their later years, it is common to adopt a more conservative investment strategy. Many investors move a greater percentage of their portfolios into fixed-income investments, such as bonds, in an effort to reduce risk exposure and volatility. This shift is driven by a desire for financial security, especially when nearing or entering retirement, where the fear of significant losses in equities—and insufficient time to recover from them—becomes a primary concern.

While this "conservative shift" might help reduce anxiety, it often comes at the cost of potential growth. Fixed-income investments typically offer lower returns than equity markets, meaning that investors sacrifice the opportunity for higher returns to achieve peace of mind.

However, Segregated Funds offer a compelling alternative to this traditional approach. With the built-in mortality and maturity guarantees unique to Segregated Funds, investors can remain exposed to higher-return equity investments without the same level of fear or risk. These guarantees ensure that a portion of your initial investment will be protected—even in the event of a market downturn—giving investors the confidence to stay in equities longer.

This ability to remain invested in potentially higher-risk, higher-reward assets, while still protecting against downside risk through Segregated Funds’ guarantees, allows you to continue seeking growth without sacrificing your "sleep quotient"—the peace of mind that your investment is safeguarded. This feature is especially valuable as you age, when the conventional advice might push you toward lower-risk, lower-return investments. Segregated Funds provide the flexibility to maintain a more aggressive investment posture with the security of capital protection, allowing you to balance growth potential with risk management.

Key Benefits of Segregated Funds

1. Principal Guarantees: One of the most compelling features of Segregated Funds is their principal guarantees, which protect the initial amount you deposit. This protection comes in two forms:
   1. Maturity Guarantee: At the maturity date, you are guaranteed the greater of a) the current market value of your investment or b) a minimum guaranteed amount (less any withdrawals and fees).
   2. Death Benefit Guarantee: If you pass away, your named beneficiaries will receive the greater of a) the market value of your investment or b) a minimum guaranteed amount (less any withdrawals and fees). This feature provides peace of mind by ensuring that your beneficiaries will receive a stable benefit even in fluctuating markets.
2. Privacy: One often overlooked but highly valuable aspect of Segregated Funds is the privacy they offer. Unlike non-registered investments that go through probate and become part of the public record, Segregated Funds remain private. When you name a beneficiary on a segregated fund, the proceeds are paid directly to that individual and do not become part of the estate. This avoids probate entirely and shields the contents of your segregated fund from public disclosure, ensuring your financial affairs remain confidential. For many individuals and families, this aspect of privacy is a significant advantage. Probate is a public process, meaning anyone can access details about the estate, including assets and beneficiaries. By utilizing Segregated Funds, investors can protect the confidentiality of their assets and maintain their family's financial privacy, shielding them from potential scrutiny or unwanted attention.
3. Estate Preservation: Segregated fund death benefits are paid directly to your beneficiaries, allowing them to bypass the estate settlement and probate process. This means your beneficiaries receive their payout faster, and the costs associated with probate fees and taxes are avoided. Additionally, because of the privacy benefits, the payout remains confidential, further enhancing estate preservation.
4. Minimize Fees: Segregated Funds allow you to minimize probate, executor, legal, and accounting fees by bypassing probate for assets held in these contracts. This can lead to significant cost savings for your beneficiaries, keeping more of your estate intact for your loved ones rather than lost to administrative fees.
5. Provide Possible Creditor Protection: Because Segregated Funds are an insurance product, they may be protected from creditor claims in the event of bankruptcy, depending on provincial laws. The interest of the named insurance beneficiaries may override the claims of creditors. This feature is particularly attractive for business owners or self-employed individuals, offering an added layer of security in protecting personal assets.
6. Lock in Gains Without Selling (Resets): Segregated Funds offer a unique feature called resets, which allows you to lock in investment gains without selling. Once per year, you may have the option to reset your guaranteed value, allowing you to lock in any market gains. For example, if your investment grows by 5% over the year, you can reset your fund to reflect the new higher value. This effectively increases your guaranteed minimum, protecting those gains while resetting the maturity date in most instances.
7. Preserve Capital and Upside Growth Potential: Segregated Funds offer protection against market downturns through maturity and death benefit guarantees. These guarantees ensure that the value of your investment is preserved at the contract’s maturity or upon death, regardless of market performance. Additionally, segregated funds provide reset features (as mentioned above), which allow you to lock in investment gains, helping to capture upside growth while maintaining downside protection.

How Segregated Funds Differ from Mutual Funds

While Mutual Funds and Segregated Funds share some similarities—such as professional portfolio management and diversification across asset classes—there are key areas where Segregated Funds stand out:

• Bypassing probate: Mutual Funds generally don’t offer the ability to bypass probate, while Segregated Funds do, which helps ensure privacy and quick payouts.
• Creditor protection: Segregated Funds provide creditor protection, which is particularly beneficial for business owners and professionals. Mutual Funds do not offer the same protection in most cases.
• Guarantees: Segregated Funds guarantee your principal (or a percentage of it) at maturity and at death, while Mutual Funds do not provide this level of protection.
• Privacy: Unlike Mutual Funds, Segregated Funds provide the added benefit of privacy, ensuring that the contents and proceeds of your investment are not subject to public disclosure through probate, maintaining the confidentiality of your estate.
• Ability to lock in gains: Segregated Funds offer reset features that allow investors to lock in market gains without selling, whereas Mutual Funds typically require a sale to realize gains.

The Cost Comparison: Mutual Funds vs. Segregated Funds

In addition to the speed of payout and the additional benefits mentioned, Segregated Funds offer another advantage: cost savings. Probate, executor fees, legal, and accounting costs can add up quickly when dealing with traditional investment vehicles. Let’s look at a practical comparison between Mutual Funds and Segregated Funds using the scenario of a $500,000 investment (as illustrated in the example below):

• Deferred Sales Charges: Mutual Funds could incur charges as high as $15,000, depending on the type of investment and timing of withdrawals. In contrast, Segregated Funds typically waive these fees upon the death of the investor, meaning no additional costs are passed onto the estate.
• Probate Fees: For large estates over $250,000, probate fees in Alberta are fixed at around $400. While this amount might seem minimal, it’s still an avoidable cost if Segregated Funds are used, as they bypass the probate process entirely.
• Executor Fees: In Alberta, executor fees can be up to 5% of the estate’s value. Even if a family member serves as the executor and the fee is reduced to 1%, this still amounts to $4,775 for a $500,000 estate. Segregated Funds eliminate the need for executor fees, as the insurance company handles the payout.
• Legal and Accounting Fees: Legal and accounting costs can run between 0.5% to 3% of the estate’s value, depending on the complexity of the estate. In this example, that amounts to $14,325 in fees—another cost that is avoided with Segregated Funds.

In this example, the total savings of using Segregated Funds compared to Mutual Funds could amount to $34,500, a significant sum that stays within the estate, benefiting the beneficiaries rather than being absorbed by legal, probate, and executor fees.

Addressing the Criticism of Segregated Fund Fees

One common criticism of Segregated Funds is the Management Expense Ratio (MER), the ongoing fee charged by the insurance company to manage the investment. While these fees can be higher than those associated with standard mutual funds, it’s important to consider the broader picture.

Yes, there are ongoing management fees with Segregated Funds, but the speed of payout (5-10 business days versus the 4-6 months or longer with probate), combined with the significant reduction in probate and legal fees, may outweigh the costs associated with the MER.

For beneficiaries, the immediate access to funds and the elimination of stressful legal processes can provide peace of mind during a challenging time. Instead of waiting months—or even years—for assets to be distributed, Segregated Fund holders can rest assured that their loved ones will receive the financial support they intended without unnecessary delays or fees.

Segregated Funds as a Tool, Not the Whole Portfolio

It’s important to note that Segregated Funds don’t need to represent the entirety of one’s assets or investment portfolio. Instead, they can be used strategically as part of a well-rounded estate plan. For example, some portion of an investor’s assets could be placed in Segregated Funds to ensure faster payouts, privacy, and cost savings for beneficiaries, while other assets remain in different investment vehicles. This approach provides flexibility in estate planning and allows individuals to optimize both their investment strategy and their estate's efficiency.

By incorporating Segregated Funds alongside other assets, investors can diversify the tools at their disposal, ensuring that both short-term and long-term estate planning needs are met. It offers a balanced approach, where some assets are set aside for immediate disbursement to beneficiaries, while others may remain invested for the long term.

Conclusion: A Strategic Choice for Estate Planning

Segregated Funds offer clear advantages when it comes to estate planning. The quick payout, creditor protection, privacy, and potential cost savings can make a profound difference for families in the aftermath of a loved one’s passing. While there may be ongoing fees such as the Management Expense Ratio (MER), these costs are often offset by the significant reduction in probate, legal, and executor fees. Most importantly, Segregated Funds provide beneficiaries with timely access to the assets they need—when they need them most, all while ensuring that your financial affairs remain private and secure.

Moreover, Segregated Funds don’t have to be an all-or-nothing decision. They can serve as one component of a comprehensive estate plan, ensuring that families are financially protected without being burdened by unnecessary delays, fees, or public scrutiny.

When considering your estate planning options, it’s worth discussing with a financial advisor whether Segregated Funds are the right choice for you and your family.