If you are a small to medium size business owner beginning to explore providing group savings and investing plans for your employees, you have several options. Typically businesses offer a managed mutual fund or segregated funds or a combination of both.
While both mutual funds and segregated funds share some basic similarities, they also have key differences that must be understood. Historically, mutual funds have been the choice of many businesses as they provide a relatively inexpensive method of investing.
First, the similarities:
Both mutual funds and segregated funds provide the opportunity to pool funds for investing purposes. A third party makes the allocation decisions and all investment related choices. Likewise, all financial assets within each mutual fund are owned by the organization managing the pool of investments while the investors in the fund own an interest of the assets.
Now, the differences:
The primary difference between mutual and segregated funds is that segregated funds are considered insurance products sold by insurance companies. This means that the governing bodies and regulations for overseeing segregated funds are usually the same ones that cover insurance companies.
Segregated funds, unlike mutual funds generally offer a degree of protection against losses. For example, most segregated funds will guarantee around 75-100% of premiums paid (minus management and other related costs) in the event of the policyholder’s death or upon maturity of the fund. With mutual funds, if all the stocks in the mutual fund were to lose their value, investors would lose all of their investment.
In the event of death, beneficiaries of a segregated fund policy will usually directly receive the greater of the guarantee death benefit or the market value of the fund holder’s share. With a mutual fund, on the other hand, the market value of the asset is subject to the same processes that other estate assets go through. So the beneficiaries will only receive a payout upon settlement of the estate.
Below are three major advantages and disadvantages of segregated funds from GetSmarterAboutMoney.ca. For a further discussion of your business savings and investment plan, contact one of our Desjardins Fund Advisors and learn how either a segregated fund or mutual fund can play a beneficial role in your business.
3 advantages of segregated funds
- Principal guaranteed – Depending on the contract, 75% to 100% of your principal investment is guaranteed if you hold your fund for a certain length of time (usually 10 years). If the fund value rises, some segregated funds also let you “reset” the guaranteed amount to this higher value – but this will also reset the length of time that you must hold the fund (usually 10 years from date of reset).
- Guaranteed death benefit – Depending on the contract, your beneficiaries will receive 75% to 100% of your contributions tax free when you die. This amount is not subject to probate feesif your beneficiaries are named in the contract.
Potential creditor protection – This is a key feature for business owners in particular.
3 disadvantages of segregated funds
- Your money is locked in – You have to keep your money in the fund until the maturity date (usually 10 years) to get the guarantee. If you cash out before that, you’ll get the current market value of your investment, which may be more or less than what you originally invested. You may also be charged a penalty.
- Higher fees – Segregated funds usually have higher management expense ratios (MERs)than mutual funds. This is to cover the cost of the insurance features.
Penalties for early withdrawals – You may have to pay a penalty if you cash out your investment before the maturity date.
Retail versus group retirement plan segregated funds
If you have a workplace pension or savings plan that is administered by an insurance company, the fund options available to you will typically be segregated funds. However, these segregated funds do not carry an insurance guarantee and do not have the higher fees associated with retail segregated funds that you buy as an individual. However, because they are insurance contracts, they do carry the potential for creditor protection and the avoidance of probate fees if a beneficiary is named.