What clients may not know about this insurance-based investment might surprise them.
For much of the past two years, stock markets and bond yields have experienced relatively mild growth, which has led some investors to question their continued commitment to routine investing and perhaps consider other options. Additionally, a large segment of the population is aging, and beginning to think about their legacy. These developments have a bright side for advisors, who can place themselves at the centre of the estate-planning conversation and the best vehicles to manage it.
Emphasize estate planning
By a certain age, most people have acquired a variety of assets, possessions and other instruments of wealth that, together, form their estate. With that estate comes a responsibility for planning for the day when it will be distributed to others who are near and dear. As with many other important financial decisions, advisors can play a critical role in helping clients navigate the matter of distributing or transferring wealth upon the event of their death – their estate plan.
When it comes to making the decisions that will carry a client’s legacy forward, two questions about the investment portion of their estate come to mind: (1) What is the value proposition? (2) How do I transfer my wealth to my loved ones? The planning needs to be well thought out and carefully delivered and communicated. Generally, the more complicated the estate, the more sense there is in developing a plan – and it’s never too early to begin.
Because the details of an estate plan can be complex, settling an estate can test the patience and resolve of beneficiaries and executors alike. Anticipating this complexity can shine some light on the advantages of owning segregated fund contracts.
Unique benefits
Segregated funds are structured as deferred variable annuity contracts with life insurance benefits. They are managed in separate accounts, and in some ways, are similar to other variable annuity products offered by insurance companies.
Among the many unique features of segregated funds, however, is the path they provide to instant liquidity. That is, beneficiaries can have access to money left behind for them well before the estate settles – usually within a matter of weeks. To look at it from another angle, given the choice to wait two weeks or two years to receive their funds, most people, if not everyone, would choose quicker access.
Another helpful advantage that segregated funds offer over other estate-planning instruments is that they enable the contract owner’s assets to bypass probate (the process that confirms the validity of a will and the authority of the executor, or the estate trustee, to administer the estate) and thus to avoid the fees associated with the process. This is of critical interest to beneficiaries, since the timely transfer of assets can be delayed by probate. The process can sideline the distribution of funds by several months or years (with larger, more complicated or contentious estates potentially taking even longer). With a segregated fund, the estate can be distributed as the owner wishes without having to establish a trust. In some provinces, holding segregated funds can also result in more control over individual privacy,1 a welcome benefit: when a will submitted for probate becomes a matter of public record, the details are accessible to anyone for a small fee.
Some segregated funds may also offer a cost-free annuity settlement option. This option allows the owner to stipulate that the death benefit be used to purchase an annuity that releases regular payments to a beneficiary (instead of a lump sum, which can present a host of other issues for people who perhaps are not prepared to manage a large amount of money at once). The payments can be rolled out for a specific length of time or over the beneficiary’s lifetime. Clients may be attracted to the flexibility this brings to distributing funds to beneficiaries.
Unlike mutual funds, segregated funds guarantee to protect a portion of the money invested. Even if the underlying fund loses money, a segregated fund contract holder is guaranteed to get back at least 75 per cent of their principal investment. To recoup the benefit from the guarantee, the investment must be held until the annuitant reaches a certain age or for a specific period (e.g., 10 years). Some segregated funds also offer resets to lock in growth, while others include an option that can deliver lifetime guaranteed income.
At a glance
Here’s a list of some of the unique benefits associated with segregated fund contracts that may be of particular interest to clients.
- The death benefit payout of a segregated fund passes quickly and directly to the named beneficiaries.
- The benefit bypasses legal, administration and probate fees associated with the estate, leaving more for beneficiaries.
- The estate is distributed in accordance with the owner’s wishes without establishing a trust.
- Wealth transfers remain private, and the disclosure of information is minimized (not applicable in Saskatchewan).2
- Segregated funds offer potential protection from creditors while the owner is alive, and from estate creditors upon death.
- Beneficiaries of a segregated fund are easier to change than those named within a will.
- The benefit is not subject to any challenges to the will or estate litigation, reducing the potential burden and liability for the estate’s executor.
- A segregated fund contract can be an effective tool for financial gifting.
- Transferring ownership of segregated funds is a relatively simple process.
- Guaranteed Investment Accounts (GIAs) and Daily Interest Accounts (DIAs) can be held within a segregated fund contract.
- An annuity settlement option, if offered, allows the death benefit to be used to buy an annuity and set up regular payments to pass to the beneficiary for the remaining years of their life or for a specific period.
Keep up to date
Since such a massive amount of wealth will be transferred to younger generations over the next 10 to 20 years, it’s crucial that clients review and update their beneficiary designations on all appropriate investments, pensions, property and other non-registered investments. Unless steps are taken to ensure the intended beneficiary is named on the account, the money could end up in the hands of someone who was named a beneficiary at an earlier time, which could cause substantial legal issues as to who should receive the funds after the contract owner’s death. Unlike workplace pensions, registered investments such as RRSPs, RRIFs or TFSAs have no default spousal benefit, and therefore, it’s important to ensure the money is destined for the correct individual. Note that in Quebec there are different rules regarding beneficiary designations in the event of divorce.
When the estate settlement process is underway, segregated funds enable the advisor to perform the service that the client expects and the family appreciates, to deliver a cheque or cheques in a reasonable amount of time, as well as to offer ongoing asset management services to those beneficiaries.
When it comes to settling estates and distributing the bequests of a will, everyone should be protected from the problems that can arise if some of the terms of the estate are challenged. Inadequate planning can open family wounds that may never heal if the proceeds of an estate are wrongfully awarded or end up devoured by legal fees. Segregated funds can effectively sidestep many of the disputes that can otherwise tarnish the estate settlement process.
Online tools
A variety of online tools are available to help you do business on behalf of your clients, including Manulife’s Estate Cost Comparison Calculator, designed to illustrate the potential rewards of segregated funds. The calculator can show, for example, that while initial costs appear higher for segregated funds, money can be saved after the contract owner’s death. The tool is programmed to generate a report that highlights which approach may best suit a client’s interests and needs.
Manulife continues to hold an advantageous position in the segregated fund marketplace and seeks to increase that position for wealth transfer in the future. More information about the company’s segregated funds lineup is available here. See how advisors can be the quarterback for a client’s estate plan. This guide provides a comprehensive overview of setting up segregated fund contracts and GIAs.
Be sure to also make good use of eTrack, which you can use to track the status of your clients’ segregated funds, among other transactions and non-financial requests, giving you greater visibility and access to not-in-good-order messages that alert you if more information is required. eTrack also streamlines access to eDocs (formerly called Statements, Confirms and Tax Slips) through the same digital portal.
Considering annuities
Annuities are among the least understood financial products by new investors. This presents an opportunity for advisors to bring them into the conversation when they feel annuities may be a solution worth considering.
An annuity is an insurance contract that, in exchange for a single lump-sum deposit, is used to make guaranteed, regular income payments to the owner (of the annuity) for a specific length of time or for the remaining lifetime of the owner. Regardless of whether the owner lives to be 75 or 95, an annuity can contribute to a steady retirement income.
Annuities can also be gifted to beneficiaries as a means of providing regulated access to financial deposits. This can be done in the following ways:
- If the owner/recipient of an annuity (the annuitant) dies within the guaranteed period (if any), the remaining guaranteed future payments can be made to a designated beneficiary until the end of the guaranteed period.
- Financial products that include an annuity settlement option are handled by the owner while they are alive, and the annuity portion is payable after their death.
When it comes to the distribution of funds from an estate, whether through the will or a beneficiary designation, it may not be in the best interests of the recipients to come into possession of a sizable amount of money at once. An annuity may represent a viable solution if there are concerns regarding the recipient’s age, behaviour, etc.
Are annuities right for your clients? Annuities can act as a form of risk management, ensuring that even if they live longer than expected, they’ll still have payments coming in.
Annuity advantages
- Guaranteed and predictable income for life
- Protection against inflation and market volatility
- Preferred tax treatment on income payments
- A higher interest rate environment means higher income generation
Disadvantages
- Locked into the agreement for life
Even though an annuity can be the right retirement income tool for the right person, it’s only one of several items in the toolbox that can contribute to hearty long-term financial health. Performing an appraisal of client needs may lead to discovering new avenues for wealth generation and transfer. Clients may be interested in this Solutions article about annuities.
1 In Saskatchewan, jointly held property and insurance policies with a named beneficiary are included on the application for probate but do not flow through the estate and are not subject to probate fees.
2 Ibid.
