There's more to retirement planning than RRSPs
By Jim Middlemiss • Bankrate.com

Because stocks and mutual funds are subject to the vagaries of the market, investors can suddenly find themselves losing part of the capital they've invested. If that worries you, you might consider investing in a segregated fund. That's because seg funds, as they are often known, provide an element of security by guaranteeing part of your capital.

Seg funds are the insurance industry's answer to mutual funds and, as such, are sold by licensed insurance agents. They can be used inside an RRSP, where they grow tax-free, or in a nonregistered account.

How seg funds work
They are structurally different than mutual funds and are technically a form of life insurance based on a variable deferred annuity contract, says John Lutrin, executive vice-president and chief marketing officer at Hub Financial, a managing general agency that provides access to products such as seg funds to more than 3,000 independent life insurance agents in Canada.

He says it's the structure that makes seg funds appealing because it allows the manufacturers of the product to provide a range of features and benefits not available to mutual funds, including the principal guarantee.

That said, seg funds operate along the same lines as mutual funds. Investors can buy a seg fund that focuses on a range of assets classes, such as Canadian or international equities or balanced portfolios. The fund comes with a sales charge or management fee.

Overall, they are less popular than mutual funds. Canadians have $78 billion invested in the 2,000 or so seg funds that research firm Morningstar says are available, compared to $570 billion in mutual funds.

"A seg fund, like a mutual fund, is an investment product first," Lutrin says. That means before you look at the bells and whistles, you must be sure it's a suitable investment for your risk profile.

The principal guarantee
So, what are those bells and whistles? The primary feature is the principal guarantee, which can differ from one carrier to the next, says Lutrin. There are basically two choices -- investors can guarantee 100 percent or 75 percent of their principal over a 10-year period. So, if, at the end of the 10 years, the investment is worth less than what you paid, you receive the amount you invested.

In some cases, there is also a reset option, so that if the investment's value increases, you can essentially lock in those gains and restart the guarantee based on the new amount. However, this triggers a new 10-year guarantee period.

The guarantee also extends to death, so if you pass away before the 10-year period expires and your investment is under water, the principal is covered.

While the guarantee is attractive, it comes with a price. Management-expense ratios, or MERs, of seg funds are higher than mutual funds in order to cover the insurance portion. The difference can be as much as 80 basis points in some cases, though Lutrin says by shopping around you can close the gap to 4 or 5 basis points.

Bill Bell, a chartered life underwriter and certified financial planner with Bell Financial in Aurora, Ont., says he has never had a client collect on the guarantee, mostly because "we've never had a losing 10-year run in the market."