Posted on: 20-09-04 08:19:53
I have recently come across a new term in investment called segregated funds. I am told it has some very attractive features like:
1. the principal is guaranteed at maturity - which is a period of ten years.
2. It works like mutual funds - the difference is that it is issued and managed by insurance companies and treated as their asset.
3. Investment into these funds offers a tax advantage in the year of investment - the amount invested is reduced from investor's taxable income dollar for dollar.
4. At the maturity, the income is treated as capital gains and not investment income, hense giving the advantage of being taxed at 50% of your marginal tax rate.
5. Since the principal is guaranteed, the only risk is the interest portion. Anyone who has a house whose value has gone up since the house was purchased, can use this for additional returns if he does not need the cash from his increased equity. He can take another loan against the increased equity in the house/property and invest into these funds. Normall the returns on investment would be slightly more than the bank interest rate, and therefor one can arbitrage the investment without having the fear of losing the principal.
6. The valuation of the fund is done each day based on closing price of the investments made from the particular fund chosen by an investor. The investor has a choice to lock in his principal once or twice a year if the NAV goes up. For example, if one invests $10,000 on day one and say after a year the NAV of the fund goes to $11,000, the investor can lock it at that price, so his new guaranteed principal becomes $11k - only thing is that the lock in period of 10 years again starts from the day one locks in the principal base.
One of the disadvantages is that the management fees in such investment is higher than that of a normal mutual fund - perhaps the cost of insurance for guarantee on the principal.
I invite a discussion on this particular investment from personal financial planners/individual investors/guys and gals from finance background, and anyone who finds this topic interesting.
Chandresh
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Chandresh
Advice is free – lessons I charge for!!
I don't think point #3 is right...You don't get a tax deduction unless it is in a RRSP.
Seg funds and their working
What are Seg Funds
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Segregated funds (seg funds) are often described as 'mutual funds with an insurance wrapper.' Much like mutual funds, money invested in a seg fund is pooled to purchase a portfolio of securities, which allows the investor a certain number of fund units. The numbers of units is based on the value of the underlying securities and will change in response to market conditions.
This is exactly where mutual funds and seg funds begin to diverge. Seg funds are distributed by life insurance companies and are available only from financial advisors who are licensed to sell life insurance.
The issuing insurance company keeps seg funds separate from the rest of its assets. Hence, the name 'segregated' funds.
An investment in a seg fund is actually a deferred annuity, which is an investment contract with a specified maturity date. Generally, maturity is a minimum of 10 years from the date of purchase. Similar to traditional mutual funds, Segregated Funds are especially attractive to business owners or professionals seeking creditor protection.
How Segregated Funds work
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Segregated Funds are an insurance product, combining a mutual fund-like investment with the protection of an insurance policy. As with mutual funds, an investor's money is pooled with the contributions of other investors to purchase a portfolio of securities. The value of the units purchased is based on the value of the underlying securities and will change in response to market conditions.
Are Segregated Funds right for you?
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Deciding if Segregated Funds are right for you will depend on your objectives, the length of time you plan to invest and your risk tolerance. Entrepreneurs, business owners and people whose work exposes them to professional or personal liability may wish to take advantage of this investment opportunity. It's up to you and your financial advisor to decide whether Segregated Funds provide the best option in your situation.
Segregated Funds offer these features and benefits:
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Potential creditor protection
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Segregated Fund investments may be protected from creditors — provided the funds are invested for at least one year, the investor is not already insolvent at the time of purchase, there is no fraudulent intent at the time the purchase is made in the Segregated Fund and a 'family-class' beneficiary is named. Creditor protection is not certain in any circumstance. Consult your legal counsel for further information.
Estate and probate fees
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On death of the annuitant proceeds from Segregated Funds are not subject to certain estate or probate procedures.
Basic guarantees
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Provides a guarantee on 75 per cent of all deposits made to the policy (less a proportionate reduction for withdrawals) on death and maturity.
Basic guarantees with Enhanced Guarantee Rider (EGR)
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By adding the EGR, ten years from the date of the client's first deposit year (which starts when the EGR has been added), the market value for that deposit year is guaranteed to be 100 per cent of deposits. Each deposit year within the policy will have a similar ten year, 100 per cent guarantee. The death benefit guarantee starts at 75 per cent for each deposit year and increases by five per cent each year until it reaches 100 per cent. (All guarantees are less a proportionate reduction for withdrawals.)
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Pramod Chopra
Senior Mortgage Consultant
Mortgage Alliance Company of Canada
Good explanation Pramodji - just as I had expected from you. ( I have come to expect a lot from you!!!)
Can you comment on the tax advantages, if any, and withdrawl procedures/penalties before maturity?
Aslo, it is possible to pledge this investment to get a temporary loan from a financial institution (insurance company/bank or broker company)?
Chandresh
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Chandresh
Advice is free – lessons I charge for!!
Quote:
Orginally posted by chandresh
Good explanation Pramodji - just as I had expected from you. ( I have come to expect a lot from you!!!)
Can you comment on the tax advantages, if any, and withdrawl procedures/penalties before maturity?
Aslo, it is possible to pledge this investment to get a temporary loan from a financial institution (insurance company/bank or broker company)?
Chandresh
Thanks Chandresh ji,
I will certainly find out the answers to these questions and would post them tomorrow as I do not wish to give any incorrect/incomplete information though I think it is possible to get loan against this to the tune of your guaranteed cash amount.
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Pramod Chopra
Senior Mortgage Consultant
Mortgage Alliance Company of Canada
Pramodji,
Any progress?
By the way, I thought we had many financial experts on the forum - including Yours Truly and the entreprenuer, DP Jain, Sathish, etc. and had hoped to get some input from them. I personally found this investment to be really good one for arbitrage purposes and therefore wanted to share with all - and also know if there are some pitfalls that I cannot see.
Chandresh
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Chandresh
Advice is free – lessons I charge for!!
Hi Chandreshji,
Like you I was also awaiting Pramodji’s reply. But I guess he is too busy right now.
Basically we want to explore the possibility of ‘arbitrage’ (I’d call it leverage) by investing home equity in Seg funds.
Let me begin with a historical fact: At no point in history the North American markets have shown negative growth in any 10-year block. I am not saying it won’t happen in future but chances of it happening are bleak.
Based on this information we can say that when we invest in Seg funds we are paying extra just to guarantee our principal which anyway is secure based on historical data. On top of that if we invest borrowed money, we are not investing efficiently. There are better investment opportunities if one wants to leverage.
By stating the above I do not intend to say that Seg funds should be avoided. On the contrary these investments have very useful features that appeal to certain type of investors. These features are maturity and death guarantee and credit protection.
A few words on premature withdrawal and tax:
A majority of Seg funds have withdrawal fee that decreases with the number of years you hold the investment. For example, if after one-year your investment increased and you want to withdraw, you may pay as much as 5 to 6% withdrawal fee.
The maturity and death guarantee benefits are taxed as capital gain. Any gain accrued on reset is not treated as capital gain in the year of accrual
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