Segregated funds and estate planning

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Segregated funds may be extolled for their maturity guarantee – that is, the guarantee that when the contract matures, after a minimum 10-year investment, 75% of the initial investment is guaranteed to be repaid. However, seg funds also offer a death benefit guarantee, which has interesting implications for those who have health concerns, their investment risk, and estate planning.

The death benefit guarantee is like the maturity guarantee: a guaranteed percentage of investment returned if the annuitant of the policy dies while the contract is in place. (The annuitant is the person on whose life the contract is based. This may be the same person as the policyowner or another.) The payment is made to the beneficiary of the contract. That amount may be equal to the maturity guarantee (75%), or it may be greater than the maturity guarantee – for instance, it may be 100%. The guarantee depends on the issuer of the policy and will be clearly stated in the contract.

It is important to bear in mind that the amount paid for both guarantees is a guaranteed minimum. If market value of the investment is greater than the guarantee, then the market value is paid.

The death benefit is paid whenever death occurs. This could be the day after the policy goes into force. If the policy is issued with a deferred sales charge (DSC), and death occurs during the period the DSC is in effect, the death benefit may be reduced by the sales charge, but many issuers waive the sales charge at death.

There is no medical underwriting when an application is made for a segregated fund contract. The contract is considered an investment, not a life insurance policy. Therefore, a person with a medical condition that could lead to a shortened life expectancy can make a seg fund investment and receive the death benefit guarantee.

Expanding risk capacity

How is this related to risk and the estate? The death benefit guarantee of the seg fund allows the investor, if he or she can accept the concept, of assuming a higher degree of risk in investing because there is downside protection. The investor can be certain of the minimum payout at death, so he or she has more risk capacity. If the market value is greater than the minimum at the time of payout, then the beneficiary receives market value.

Meanwhile, wills exist to disburse estate assets. All wills are based on a formula for disbursement as follows: estate value minus debt or other obligations minus specified bequests equals residue. If estate value is less than anticipated, debt payment, bequests, and residue can all be affected. This can be true when non-guaranteed investments comprise part of the estate.

Seg funds and wills

However, a seg fund removes the proceeds of investment from the will when a beneficiary has been named. The beneficiary is assured of receiving the minimum guaranteed sum. There can be multiple beneficiaries of a contract, and the amount they each receive does not have to be equal. For example, Beneficiary A could receive 50% of proceeds, while B, C, D, E, and F each receive 10%. Contingent beneficiaries can be named if an original beneficiary dies. And beneficiaries can be changed with written notice to the insurer that has issued the contract.

Therefore, a will and its corresponding estate plan can be formulated without consideration of beneficiaries because they will benefit from the seg fund contract guarantee.

Probate fees are also reduced by moving the investable sum into a segregated fund because fund proceeds fall outside the estate.

This can bring great peace of mind to an investor with poor health prospects, because there is a certainty that beneficiaries will receive no less than the minimum sum. If the investor lives to the time of contract maturity, the contract may be renewed (depending on age), at which time guarantees will also renew.

Courtesy Fundata Canada Inc. © 2016.Susan Yates is president of the Centre for Life Insurance and Financial Education (clifece.ca).Securities mentioned carry risk of loss. This article is not intended as personalized advice.