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Should I switch to seg funds from mutual funds?

by Glenn on January 15, 2009

In the current investment climate, the guarantees inherent with a seg fund can start looking attractive to many people. So should you switch your investments from mutual funds over to seg funds?

The initial response to that would be yes – if you are willing to pay a slightly higher management fee in return for the guarantees we get with seg funds. But there’s at least one thing to consider before doing this – when should you make the switch?

We know that seg funds have minimum guarantees on your deposits (which would include your initial transfer). What isn’t normally guaranteed directly is your growth.

Now let’s assume that your investments will recover from their current abysmal level. Note that the markets generally correct or come back in fast spurts – over the course of a day or so, not over months. You’ll wake up one morning and it’ll be mostly back.

Let’s say you had $100,000 last year in mutual funds. Right now you’ve got $60,000. We expect it will return to $100,000 at some point in the future (that’s a basic underlying principle of the markets).

Now if you make the switch to seg funds now, your guarantees will be based on the $60,000. When the markets return, the growth of $40,000 isn’t generally speaking included in the guarantees.

However if you wait until your mutual funds return to $100,000 and then transfer over to a seg fund, your guarantees in the seg fund will be based on $100,000.

What to do? There’s no general answer to this as it depends on whether you believe your mutual funds will come back given your current investments, it also depends on some of the insurance companies’ seg guarantees. And the length of time you have until your maturity date should be considered as well – can you wait for your mutual funds to recover?

Like many things in the markets what we should do is the opposite of what we want to do. The best time guarantee-wise to move from a mutual fund to a seg fund is when markets are high, to lock in those guarantees. However the time most people want to trade off the higher fees for the guarantees is when the markets are low.


Seggregated fund guarantees

by Glenn on January 15, 2009

In my last post I touched on the difference between seg funds and mutual funds. Now I want to touch on what guarantees are available within seg funds.

Seg funds all have a minimum guarantee, but these guarantees vary by company. The following is a brief outline of what I would consider to be the basic guarantee (some companies may provide better).

When you invest in a seg fund you will select a maturity date. This is generally age 71 (the age the government requires you convert your RRSP to a RRIF). The base assumption would be that the guarantees kick in at that time.

At maturity, all deposits that were made 10 or more years ago are 100% guaranteed. Any deposits made in the last 10 years would be 75% guaranteed.

Let’s say you’ve been investing for 20 years. In the first 10 years you invested $100,000. In the last 10 years you invested another $100,000. If your investments have crashed to the point where you actually have less than that initial $200,000, the guarantees will kick in – the insurance company will actually top up your investment. So the first $100,000 will be topped up completely, and the second $100,000 will be topped up to a maximum of $75,000. So worst case scenario at the maturity date would be a guarantee of $175,000.

The same guarantee is available at death.

A few more points. First, this is only a general idea of how the guarantees work for seg funds. All the companies have their own base guarantees, similiar to but different from the above. There are also additional complications like ‘resets’ from some companies that allow you to lock in your growth (basically saying that as of today, all your growth is treated as a new deposit, thus in 10 years the minimum guarantee would apply to your funds’ current amount).

Mutual funds do not offer this guarantee. As I noted previously, seg funds commonly have slightly higher fees. You’ll need to review the difference in fees with the guarantees to see if seg funds are right for you.


Seggregated funds vs mutual funds

by Glenn on January 15, 2009

Many Canadians keep their RRSP retirement savings in some form of mutual funds. We do have an alternative though – seggregated funds.

Seggregated funds (or Seg funds) are basically mutual funds offered by life insurance companies. There are some fine technical differences (you’re not investing in the underlying funds, you’re investing in the seg funds which holds units in the funds) but effectively, they pretty much look like mutual funds.

There’s two important differences between seg funds and mutual funds though. First, seggregated funds generally have higher MER fees – the costs are a bit higher. Secondly, seg funds have base guarantees of capital. That’s right – unlike a mutual fund, seg funds offer guarantees of the capital you invest into the seg funds. These guarantees may not be 100% (though in many cases they are 100%) and they kick in after a length of time, generally 10 or 15 years.

The question is – are you willing to pay the slightly higher MER fees in exchange for those guarantees? That really depends on your aversion to risk. If you don’t care about the volatility of mutual funds, take the lower costs. If you prefer some basic guarantees on the money you put in, consider seg funds.



by Glenn on January 6, 2009

InsureCan has just released a TFSA vs RRSP calculator. It compares and contrasts two scenarios; if you make an annual deposit (plus refund) into an RRSP, or if you make a partial deposit into an RRSP with the remainder going into a TFSA.

This currently is the only calculator of it’s kind online at this time.  Other Tax Free Savings Account calculators merely show how the tax deferred growth is beneficial, they don’t actually compare to deposits made into a Registered Retirement Savings Plan.  This new calculator however, shows deposits and growth, then the effects of taxation on withdrawals after retirement. It helps answer the question ‘Will I have more money at retirement if I invest in a TFSA or if I invest in an RRSP?’.


RRSP vs TFSA – Tax Free Savings Accounts

by Glenn on May 7, 2008

In the last budget, the federal government created a new savings plan called a TFSA (Tax Free Savings Accounts). These savings plans will be available starting in 2009. These savings plans are similiar to to RRSP’s, with some technical but important differences.

Deposts to fund are tax deductible? No Yes
Growth/interest earned is tax sheltered while inside the fund? Yes Yes
Withdrawals are taxable? No Yes
Withdrawals affect other government benefits (OAC, GIS, etc) No Yes
Maximum contribution $5000 lesser of $19,000 or 18% of your earned income

Because TFSA’s aren’t taxed on withdrawal as RRSP’s are, and the withdrawals aren’t treated as income and thus affecting your other government benefits, TFSA’s may be a very attractive option in conjunction with or in addition to RRSP’s. They’re less beneficial right now (since you receive a tax deduction for RRSP contributions but not TFSA contributions) however after retirement they have some very attractive benefits.

Unlike some other investments you cannot deduct interest costs if you borrow to contribute to a TFSA. You will likely be able to invest in similiar investments to RRSP’s once these savings accounts become available.

Upon death, your estate will receive the funds from the TFSA tax free. Alternatively (and probably a better idea) you can specify a spouse or partner as a successor account holder – pretty much a beneficiary. That transfer won’t affect their existing TFSA.

So, TFSA’s sound like a great idea in conjunction with RRSP’s. They give us additional ability to grow our retirement savings in a tax sheltered fashion and they won’t decrease our other benefits and income when we withdraw them after retirement.

Coming soon: a TFSA calculator.