Segregated funds have several uses as a financial planning tool, primarily in the area of estate planning. As you may know, segregated funds (or seg funds for short) combine the features of a mutual fund with elements of an insurance contract. One of those insurance elements is the death benefit guarantee, which ensures that a specific percentage of the value of your client’s investment pays directly to their beneficiaries at the time of death. This death benefit payment may even bypass probate, which streamlines the process of estate settlement and makes it easier for your client to pass investment assets on to those they love. Seg funds must provide at least a 75% death benefit guarantee, but the guarantee can be up to 100%.
The death benefit guarantee also adds a level of security that is not available in a mutual fund. This can be increasingly powerful for clients who are in retirement or approaching retirement – it allows them to participate in funds with potentially higher returns than guaranteed options such as GICs. The death benefit guarantee forms a “safety net” that provides an element of protection against market risk in these funds.
An additional feature, which involves the death benefit guarantee and strengthens a seg fund contract, is the guarantee reset. Some seg fund contracts provide the option to exercise a guarantee reset when the market value of an investment account is higher than the current death benefit guarantee value. Executing a reset increases the death benefit guarantee to match the current market value; guarantee resets are usually limited to one or two resets per calendar year.
It’s important to note that certain transactions in a seg fund policy affect the death benefit guarantee. Additional deposits to a policy increase the death benefit guarantee, while redemptions from a policy reduce the guarantee – often proportionately. When the annuitant of the policy dies, the beneficiary will always receive the greater of the guarantee value or the current market value.
The following scenarios illustrate the function of a death benefit guarantee:
Scenario 1: Client A opens a seg fund contract with an initial deposit of $100,000. The contract includes a 100% death benefit guarantee. Unfortunately, Client A passes away 18 months after opening the contract. A market correction causes the value of the investment account to drop and the value at Client A’s death is $92,000. Since the contract carried a 100% death benefit guarantee, the insurance company applies a “top up” to the account and Client A’s beneficiary receives a death benefit payment of $100,000 – the full value of their initial investment.
Scenario 2: Client B opens a seg fund contract with an initial deposit of $100,000. The contract includes a 100% death benefit guarantee. The market value of the investment increases to $108,000 over the following six months so the client submits instructions for a guarantee reset, which increases the death benefit guarantee value to $108,000. Unfortunately, Client B passes away 4 months after the reset. At the time of death, the market value of the investment was $103,000. Since Client B’s beneficiary receives the greater of the current value and the death benefit guarantee value, they will receive a death benefit payment of $108,000.
A comprehensive understanding of death benefit guarantees is essential in highlighting the benefit of segregated funds to your clients. It can be a valuable feature in many different financial planning scenarios.
For a similar article about segregated funds, read Segregated Funds and What They Mean for your Client and watch PPI’s SMART TALK video Growing and Protecting your Retirement Savings, both of which are shareable with your clients.
For more information on segregated funds and the death benefit guarantee, please contact your local PPI office.