If you’ve ever consulted a financial advisor, it’s possible they’ve thrown in the term “segregated funds” — or “seg funds,” as industry insiders say. This article explains what segregated funds are, how they work, how they compare to mutual funds, and the advantages and drawbacks to weigh before you invest.
What are segregated funds
A segregated fund is an investment product wrapped in an insurance contract. It pools your money into underlying assets like stocks and bonds, while guaranteeing a portion of what you invest — usually at least 75%, and sometimes 100%. So even if those underlying assets lose money, you’ll still get some or all of your principal back.
Because these are insurance contracts, they’re mainly sold by Canadian insurance companies through licensed insurance advisors and are not traded on a public market. The name “segregated fund” comes from the fact that your money is kept in a pool that’s legally separate, or segregated, from the insurer's own assets.
As with any investment, there is an element of risk and a chance you could see losses along the way. The guarantee is what sets these contracts apart, protecting part of your principal even when the market falls.
How do segregated funds work
A segregated fund works in two layers. First, your money is pooled with other investors' money and invested in underlying assets like stocks and bonds, so your contract can grow over time. Second, an insurance guarantee sits on top of those investments and protects a portion of what you put in.
That guarantee is tied to two moments: the contract's maturity date and the death of the policyholder. If the market value of your investment is below the guaranteed amount at either point, the insurer tops it up to the guaranteed level — usually 75% or 100% of what you invested, less any withdrawals. To benefit, you generally need to hold the fund until maturity, which is often 10 to 15 years away.
What’s the difference between segregated funds and mutual funds?
The main difference is that segregated funds are sold by insurance companies and usually include guarantees that protect your initial investment. Mutual funds offer no such guarantee, but they tend to be more flexible and charge lower fees.
Feature | Segregated funds | Mutual funds |
|---|---|---|
| Sold by | Insurance companies, through licensed advisors | Investment firms, banks, and brokers |
| Principal guarantee | Yes, typically 75% to 100% at maturity or death | No |
| Fees | Higher, to cover the insurance features | Generally lower |
| Flexibility | Lower; guarantees favour holding to maturity | Higher; easier to buy and sell |
| Estate benefits | Can bypass probate with a named beneficiary | Typically pass through the estate |
Segregated fund policies can offer guarantees for both maturity and death benefits. When the policy reaches its maturity date, or when you pass, if your investment is worth less than its guaranteed value, the insurance protection kicks in.
Advantages and disadvantages of segregated funds
It’s worth talking to the insurance provider you’re considering to get the full details on the underlying investments, fees, and conditions. And remember, past performance is never an indicator of future performance. Here are the main advantages and disadvantages to weigh:
Advantages
Your principal is protected: the guarantee means you’ll get 75% to 100% of your investment back at the fund’s maturity date, regardless of the market price. Investments must be held until maturity, though; withdraw early and you forfeit the guarantee. A well-diversified portfolio finishing down more than 25% after a decade or more has been rare, historically.
Guaranteed death benefit: this is why segregated funds are associated with life insurance, and why you should name a beneficiary on your policy. When you pass, 75% to 100% of your initial investment is passed on to your beneficiary, generally tax free (though income or gains accrued in the contract may be taxable to your estate).
Easy estate transfer: proceeds are paid directly to any named beneficiary in your absence, without going through probate. Probate can be lengthy and expensive, so a direct payout can ease a stressful situation for your loved ones.
Potential creditor protection: if you’ve named a “family-class” beneficiary (spouse, child, parent or grandchild) or an irrevocable beneficiary, segregated funds may protect your assets from creditors in a bankruptcy or lawsuit. This can be useful for freelancers and small-business owners. This protection is not absolute — it can be challenged if the investment was made to avoid existing creditors or shortly before insolvency.
“Reset” options: some funds let you “reset” the guarantee upward if your policy’s market value rises. It also restarts the maturity clock, so it’s essentially the same as buying a new contract.
Disadvantages
Higher fees: segregated funds usually carry higher management expense ratios (MERs) than mutual funds, because the fees cover the insurance features. You may also pay commission when the fund is bought or sold, and higher MERs can have a big impact on returns.
Early withdrawal penalties: withdrawing before the maturity date will likely trigger a penalty, on top of forfeiting any principal guarantee or death benefit.
Guarantees can shrink: this varies by contract, but the death-benefit guarantee on new deposits often reduces past about age 80, and the option to “reset” the guarantee usually ends around then.
Who should consider segregated funds
Segregated funds tend to suit people who want market exposure but can't stomach the risk of losing their principal, and who are comfortable holding an investment for the long term. Common examples include:
Pre-retirees and retirees who want to protect their savings from a downturn.
Estate planners who want money to pass to a beneficiary quickly and outside probate.
Self-employed people and small-business owners who value the potential creditor protection.
They tend to be a weaker fit if you might need to withdraw your money before the maturity date, or if keeping fees as low as possible is your main priority.
What to weigh before you invest
Segregated funds offer an uncommon mix of market growth and a guarantee on your principal, plus estate and creditor benefits that most investments don't provide. Those features come at a cost, mainly higher fees and less flexibility if you need your money early.
Before you buy, ask the insurance provider for the full details on the underlying investments, the guarantee level, and every fee and condition attached to the contract. And remember that past performance is never a reliable indicator of future returns.
