For Canadian investors who want the growth benefits of investing, but the security of an insurance product, you have a unique option—the segregated fund.
Segregated funds have attractive “principal guarantees” that allow you receive 75% to 100% of your initial investment, not to mention some unique features like death benefits and creditor protection.
What exactly are segregated funds? How do they work, and are their benefits worth the costs? Let’s break them down and find out.
What is a segregated fund?
A segregated fund is a contract between you and a life insurance company that allows you to invest in an underlying asset (usually a mutual fund) at a lower risk than normal.
Recall that funds are baskets of investments (stocks, bonds, commodities, or other securities) that help you diversify your investment portfolio.
Segregated funds follow this idea, but with a twist: instead of purchasing your fund through a brokerage, you buy a segregated fund through an insurance company. And, instead of taking on 100% of the market risk, your segregated fund guarantees you’ll get back 75% – 100% of your starting investment.
When you buy a segregated fund, an insurance company will take your initial investment and reinvest it in various underlying assets (stocks, bonds, or a fund). Just like mutual funds, a segregated fund is actively managed by a fund manager, usually a financial expert who’s trying to beat the market and make your fund grow.
How do segregated funds work?
As a hybrid between insurance and investing, segregated funds are far different than any other investment products. To show you how a segregated fund works, let’s break it down into five essential parts:
1. Segregated funds are sold by life insurance companies
A segregated fund isn’t technically an investment product: it’s an insurance contract that protects a portion of your deposit for a specific amount of time.
Keep in mind: segregated funds are owned by life insurance companies, not you. Once you sign your contract, you’re giving your money to the company, and you’ll have limited access to it until your contract ends.
2. They have principal guarantees
Perhaps the most attractive feature of a segregated fund is the guaranteed return of 75% to 100% of your initial deposit (the “principal”). While the earnings aren’t guaranteed, you can be confident you’ll still get something at the end of your contract, less any withdrawals you may have made.
The more you’re guaranteed to get back, the higher the fees on your segregated fund. A segregated fund with an 100% principal guarantee, for example, will be more expensive than a fund with a 75% guarantee.
3. Segregated funds are time-sensitive
Every segregated fund comes with a contract, which usually lasts 10 years, though some can be as long as 15 years. Once you put money into a segregated fund, you’re no longer in control of it until your contract ends.
4. They come with death benefits
Another attractive feature of segregated funds is the death benefit. If you were to pass away unexpectedly before your contract ends, the death benefit allows you to pass your segregated fund to a beneficiary: your spouse, kids, or someone else you named in your contract.
Once your death has been confirmed, your life insurance company will give your beneficiary one of two things: either the guaranteed principal (the 75% to 100% of your initial deposit) or the market value of your fund’s investments, whichever one is higher.
5. You can customize your payouts
Once your contract ends, the fund starts (finally, right?): you get your money back, hopefully with some earnings from your investments. You can choose to get all your money at once (the “lump sum” option), or you can schedule monthly, quarterly, or even yearly payouts, if you want to spread your money out.
What are the advantages of segregated funds?
Segregated funds are a unique hybrid investment product combining elements of mutual funds with the protective features of insurance contracts. Offered by life insurance companies, they provide distinct advantages that can help manage risk while offering growth potential. Below are some major benefits of adding segregated funds to your investment portfolio:
1. You can protect your initial deposit
One of the most compelling advantages of segregated funds is the maturity guarantee—usually 75% to 100% of your initial investment. This guarantee ensures that, regardless of market fluctuations, you’ll receive all or a portion of your principal investment back at maturity (typically 10 years) or upon death, as long as you meet the contract’s terms.
This feature is especially appealing to conservative investors or retirees who want market exposure but also value capital preservation.
2. Segregated funds come with creditor protection
Segregated funds may offer creditor protection, provided certain conditions are met (such as naming a qualified beneficiary like a spouse, child, or parent). This means the investment can be shielded from seizure in the event of bankruptcy or legal judgment, making segregated funds an effective tool for small business owners, professionals, and others at higher financial risk.
Even in extreme scenarios, such as litigation or insolvency, your investment can be preserved for your named beneficiaries rather than being tied up in legal claims.
3. Death benefits avoid the probate process
Upon the investor’s death, segregated fund contracts typically allow the death benefit to be paid directly to named beneficiaries, outside the estate. This allows your heirs to avoid the probate process, which can be time-consuming, costly, and public. This not only speeds up the transfer of funds—often within a few weeks—but also keeps the transaction private and confidential, which is especially important for families who value discretion.
4. Reset Options for Guarantees
Many segregated fund contracts allow you to reset the guarantee value periodically. If your investment grows in value, you can lock in those gains as your new protected amount—effectively increasing your guaranteed payout.
5. Estate Planning Simplification
Because segregated funds are insurance products, they fall under insurance legislation rather than probate law, simplifying estate planning and allowing you to designate multiple beneficiaries, assign percentages, and even create contingent beneficiary structures.
What are the disadvantages of segregated funds?
Segregated funds can certainly help you balance investing risks, but don’t think they’re free. Before you buy a segregated fund here are some disadvantages you should consider.
1. Segregated funds can be costly
Expect to pay fees. Lots of fees. Because segregated funds protect a portion of your initial deposit, they’re far more expensive than mutual funds. Here are the main fees you can expect to pay.
- Management fees are what you pay to your segregated fund’s manager. These fees cover the services they’re providing to you (investment advice, managing the portfolio, making investment decisions).
- Operating costs cover all the administrative and accounting work related to your account.
- Insurance fees are what you pay to enjoy the principal protection. These fees depend on how much of your principal you choose to get back (75% to 100%), as well as any additional benefits you might add to your policy.
If you buy a segregated fund through an insurance agent, you may have to pay agent fees. Typically, the insurance company who issues the segregated fund will pay commissions directly to their agents (not you), though sometimes those costs are built into your management fees.
2. You have limited access to your money
Once you give your money to an insurance company, you forfeit your right to access it. If you have an emergency, and you need to withdraw money from your segregated fund, it’s going to cost you. You’ll lose your principal guarantee, and you may have to pay an early withdrawal penalty.
3. Investments tend to be conservative
When you think of an insurance company, do you think of an aggressive investor capitalizing on growth companies? Nope. Insurance companies, by nature, want to take the path of minimum risk.
Because of this, don’t expect your fund manager to buy and sell investment with an eye toward big gains. More than likely, they’ll buy conservative investments with only a moderate level of growth.
How to start investing in segregated funds?
Here are three steps to begin your investments.
1. Pick a Reputable Insurance Company
Segregated funds are offered exclusively by life insurance companies, so your first step is choosing the right provider. You can buy these funds directly through a licensed insurance advisor or sometimes through insurance-affiliated financial institutions.
Be strategic when selecting a company. Look for providers with:
- A strong reputation for financial stability
- A track record of competitive fund performance
- Clear, transparent disclosure of fees and conditions
It’s also smart to compare fund management fees, insurance guarantee terms, and fund options across multiple insurers. Some providers may offer better features for specific investment needs, such as higher maturity guarantees or more frequent reset options.
2. Choose your funds
Once you’ve chosen an insurance provider, the next step is deciding which segregated funds to invest in. Your options will vary by company, but generally include:
- Indexed funds tracking broad market benchmarks (e.g., S&P/TSX, S&P 500)
- Sector-specific funds (e.g., energy, mining, healthcare, technology)
- Balanced portfolios that include a mix of equities and fixed income
Although you may have fewer options compared to traditional mutual funds, segregated funds still provide access to a diverse range of asset classes and risk levels. Consider your investment goals, time horizon, and risk tolerance when selecting a fund or portfolio mix.
3. Read your contract carefully
Before committing, it’s essential to read your segregated fund contract thoroughly. This is not a typical investment—it’s a legal insurance contract with specific terms and conditions. Pay close attention to:
- Fee structure, including MERs (Management Expense Ratios) and any embedded insurance costs
- Surrender charges or penalties for early withdrawals
- Maturity and death guarantee percentages
- Reset options that may allow you to lock in gains over time
Make sure you also understand any lock-in periods or conditions for maintaining your guarantee. If you’re unsure, don’t hesitate to ask your insurance advisor for clarification.
Are segregated funds right for you?
Segregated funds are best suited for conservative investors who don’t want to risk losing a large portion of their retirement fund to a volatile market. Likewise, if you’re near retirement, and you want to sock away a lump sum, segregated funds can give you some growth potential, without the risk of losing it all.
Segregated funds aren’t for everyone, though. If retirement is a few decades away, or you want to take a more aggressive approach to investing, you can invest in an ETF or a mutual, both of which help you diversify your investments (read: lower market risks) at a much lower cost than segregated funds.
Alternatively, you could invest in Canadian growth stocks, which could really put some fire under your investment portfolio.
FAQs
What happens if the life insurance company that owns your segregated fund goes bankrupt?
Normally, Canadian investments are covered by the Canadian Investor Protection Fund (CIPF), while savings accounts and other banking products are protected by the Canadian Deposit Insurance Corporation (CDIC). Because segregated funds are sold by life insurance companies, they’re covered by a separate organization, a not-for-profit called Assuris.
If your life insurance company goes insolvent before your contract ends, Assuris will cover $60,000 of your account, or 85% of your original investment, whichever is greater. Anything above those two, however, is not covered.
What happens if you withdraw from your segregated fund before your contract ends?
If you cash out completely, you’ll get the current market value of your underlying investments, which can be significantly less than your initial deposit. On top of that, you may have to pay an early withdrawal penalty to the insurance company for breaking your contract, not to mention you’ll still pay all the necessary fees that came with your segregated fund (management fees, operating costs, insurance fees).
What is the difference between segregated and pooled funds?
Segregated funds and pooled funds might look similar on the surface—they both bundle investor money into professionally managed portfolios—but the key difference lies in their structure and guarantees. Segregated funds are insurance products, offering perks like death and maturity guarantees, creditor protection, and the ability to bypass probate.
Pooled funds, on the other hand, are strictly investment vehicles without those insurance features. So while pooled funds might come with lower fees and more flexibility, segregated funds offer a layer of protection that can be a smart move for risk-averse investors or those looking for estate planning benefits.
Frequently Asked Questions