Segregated funds are an insurance product with investment features. They are the insurance industry’s version of mutual funds. They hold investors’ pooled money, which the manager of the fund invests in stocks, bonds, ETFs or other assets, depending on the fund’s investment objectives. While similar to mutual funds in many ways, segregated funds offer unique advantages and guarantees that mutual funds do not.
As the name implies, segregated fund assets are held separately from the general assets of the insurer. The assets are held for contract holders’ benefit and therefore cannot be seized by creditors of the company.
A Guaranteed Minimum Withdrawal Benefit (GMWB) is an optional “living benefit” guarantee that can be embedded into a variable annuity product. The GMWB allows the contract holder to, at a minimum, withdraw a fixed percentage of the total annuity premiums each year regardless of market performance. The income payments are guaranteed until the total premium is recovered. The GMWB does not require annuitization. For example, Catherine invests $150,000 into a variable annuity and selects a GMWB that provides 4% annually. The capital markets have performed terribly and as a result the variable annuity contract value is only $75,000 at the end of 10 years. Catherine is in a good position though because she will receive $6,000 ($150,000 x 4%) per year until the $150,000 is recovered.
Lifetime income amounts can be increased with deferral bonuses. A deferral bonus is based on a percentage of the initial premium and is added to your lifetime income withdrawal base. You are eligible for a deferral bonus for each year that you do not begin taking income. For example, if you contribute a premium of $200,000 to your policy your intial lifetime income withdrawal base would be $200,000 and this would be the amount used to calculate your income payments. If you deferred taking income for 10 years and were receiving a 5% deferral bonus each year, your lifetime income withdrawal base would have increased to a minimum value of $300,000 (5% of $200,000 = $10,000; $10,000 x 10 years = $100,000; $200,000 +$100,000 =$300,000).
If the policy market value increases, you have the potential to secure those gains to increase your lifetime income amount through resets that may be available on some contracts. The lifetime income amount will not decrease regardless of how the segregated funds perform. The income resets are offered every several years, depending on the carrier. This means that if the policy value is greater than the existing lifetime income withdrawal base when the reset is considered, your lifetime income withdrawal base will be increased to the greater policy value. Once your lifetime income withdrawal base has been increased, it is guaranteed for life, assuming no excess withdrawals are made.
If you would like more information about Segregated Funds or for other ways to protect your assets please contact us.
Robin Muir, CFP®, CLU®, CH.F.C.