The problem with investing $150,000 in seg funds
Often the math doesn't add up
Can Canadian investors save tax when a stock’s company goes bankrupt?
You may be able to get some tax relief when the stock of a company you hold goes bankrupt....
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 fundsJust 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).
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 eggI 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.
MORE ABOUT ASK AN INVESTMENT EXPERT:
- The best way to dump an advisor and mutual funds
- GICs have a hidden commission
- Am I protected if my brokerage goes bankrupt?
- How much of my investments should be in gold?
Share this article Share on Facebook Share on Twitter Share on Linkedin Share on Reddit Share on Email
Related Articles
Is transferring your principal residence to your corporation a good idea?
Would swapping a house for cash from a corporation save on taxes? And is this tactic worth it in...
RBC’s discount broker launches international trading—what to know before you invest
It’s a first among bank-owned discount brokers in Canada. With more banks likely to follow RBC's lead, what should...
What are the tax implications if you resell Taylor Swift tickets?
Allison resold her Eras Tour tickets instead of going to the concert. The resale website asked for her SIN,...
Should you take extra RRIF withdrawals to increase your estate?
Contrary to the conventional advice, taking more than the minimum RRIF withdrawal can at times save tax on your...
How much income can I earn while getting OAS?
If you continue working in retirement, it could cause a clawback on your OAS. Here’s how to figure out...
Estate planning for singles—is a trust company the answer?
Canadians with no children or siblings must consider estate planning alternatives. Here’s why trust companies can be a good...
What to know as Canada’s capital gains tax changes remain in legal limbo
The federal government’s capital gains inclusion rate increase has yet to become law. There’s a slight chance it may...
How to report foreign income in Canada
Canadians have reporting requirements for foreign assets, income and tax paid. Here’s how to claim each of these on...
Should you invest an inheritance in an RRSP or a TFSA?
A Certified Financial Planner provides perspective on the TFSA vs. RRSP question for a couple in their late 50s...