Should I follow my advisor's advice and invest $150,000 in seg funds?

Q: My wife will be 56 years old this year and has about $150,000 invested with a financial planner who wants to move it all into segregated funds. She expects to work for another six to 10 years. I looked at the performance and the costs (in terms of fees and penalties) of the seg funds she wants to recommend and unless the market has a major crash I don’t see the value in making the move. I have read some rumblings about a major downturn that could happen sometime in the next few years. But more than 25% of the market? Any thoughts? My fear is that she’s just looking for the commissions or is really trying to work in her best interests.

—Morgan

A: I share your concerns Morgan and it could be a commission grab. I’ve seen it before and here’s how it works:

If your original investment was placed in a deferred sales charge (DSC) fund and is now free of charges, most advisors aren’t permitted to reinvest your money back into a DSC fund and collect the large upfront commission a second time. However, insurance products are regulated by a different entity, so advisors can re-invest your money back into a DSC seg fund, get the up-front commission, and lock you in for another seven years.

Related: Segregated funds: Are the investment guarantees worth it?

Also, advisors aren’t required to report seg fund fees the way they are mutual fund fees. Moving into segs is a way for your advisor to avoid a potentially uncomfortable fee conversation.

Enough of the negative, here are three seg fund benefits.

Creditor protection—although, you get this with RRSPs and TFSAs if there’s a named beneficiary. So this benefit is really for non-registered accounts.
By-pass the estate and avoid paying the Estate Transfer Tax of Probate—although, if there’s a named beneficiary on the RRSP and TFSA you avoid the probate tax. Again, this benefits non-registered accounts, not investments in an RRSP or TFSA.

Related: The pros and cons of segregated funds

Just how much is the probate tax, and how much extra does a seg fund cost? In Ontario the probate tax on $150,000 is $1,750. How much are you paying for the estate by-pass benefit? A seg fund’s management expense ratio (MER) is generally about 0.5% more than it’s underlying mutual fund. So Morgan is it worth paying an extra $750 a year ($150,000 x .5%) to save $1,750 in probate tax?

A 100% death benefit guarantee and 75% investment guarantee (the most popular, 100/75).

If you pass away and your investment value is less than your original value, the insurance provider will bring your investment back to even, ie, if the $150,000 goes to $100,000 just when your wife passes away, the insurer will bring the account back to $150,000.

Thankfully, the majority of people won’t realize this benefit, but the odd person will. That’s insurance. Do you want insurance protection for this unlikely event?

Related: Are seg funds worth the premium?

Did you know $615 a year will buy your wife $250,000 of 10-year term insurance?

Note, that there are often re-set features available with a seg fund. So if you invest $150,000 and three years later the seg fund value is $160,000, you can reset the death benefit guarantee at $160,000. (Note, each company that issues seg funds has its own features.)

What about the 75% investment guarantee? If after 10 years your original investment is down 25% or more the insurer will bring your investment account back up to 75% of its original value.

Related: Segregated funds: A cracked nest egg

I looked at the market returns for the S&P 500 since 1926 and I could only find three 10-year periods of negative returns—1929, 1930, and 2000 with the largest loss being negative 0.9% before fees. If you added a 2.5% or more MER and/or an active fund manager that got it wrong into the equation, you could’ve been down 25% or more after 10 years if you had invested in those years.

There are cases where a seg fund may make sense but I think the majority of people can do without them. My view is that you’d be better off taking the $750 seg fund cost and putting it toward a financial/estate plan that deals with the issues a seg fund tries to solve, but I am a biased financial planner.

Allan Norman, M.Sc., CFP, CIM, Atlantis Financial/IPC Investment Corp.