If you hold a segregated fund and want to convert it to a registered retirement income fund, this is what’s involved.
I have a segregated fund (I think that is what it is called) with an insurance company that needs to be converted into a RRIF (I’m turning 71 this year). Can I convert it into a self-directed RRIF or am I required to convert to a managed RRIF?
How do segregated funds work?
Segregated funds are like mutual funds: they are both investment products that include several underlying investments, which provides diversification. Unlike mutual funds, however, segregated funds have other features that I think you should consider, Leslie.
Segregated (seg) funds generally guarantee your principal (premiums paid), both after a certain period of time and upon your death. Depending on the fund contract, 75% to 100% of your principal will be protected after 10 years.
Guarantees may seem like a good thing to a consumer, but when it comes to financial products, guarantees are often expensive to provide and therefore to purchase. It is also very unlikely for a diversified investment portfolio to have a negative return over a 10-year period, meaning the guarantee may have virtually no value.
Some seg funds also provide resets of the guaranteed value as the market value rises. However, this may also increase the time horizon over which the guarantee applies, extending the 10-year period.
Holding segregated funds in non-registered accounts
If you hold segregated funds in a non-registered account, the proceeds can be paid directly to a beneficiary without first passing through your estate, because they are insurance contracts. As such, they aren’t subject to probate and estate administration tax. In some provinces, these costs are virtually nothing, and in provinces with high probate or estate administration tax, the costs are under 2% of the asset value. The estate can be distributed more quickly, though, without the delays of estate settlement, and insurance contracts can remain private, unlike an estate that passes through a will and is disclosed to all beneficiaries.
It bears pointing out, Leslie, that registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) both allow the naming of a beneficiary, which can allow your estate to avoid probate and estate administration tax. So, that aspect of a segregated fund has no value in a registered account like yours.
Segregated funds may provide creditor protection in the event of bankruptcy. However, in some provinces, RRSP and RRIF assets have strong creditor protection already.
How much are segregated fund fees?
Segregated funds may have annual fees of 3% to 4% of your investment. It is not uncommon for seg fund fees to be 1% to 1.5% higher than those of comparable mutual funds, which may already have higher fees than other investment options. It is questionable whether these higher fees are worth the potential benefits. This is an important consideration for any investor, especially a conservative investor in a relatively low-interest-rate environment.
If you do decide to sell the segregated fund, Leslie, you may be forgoing the guarantee of your principal, but again, it may not have much value. There may be deferred fees to sell as well—your advisor can check this for you.
Selling a segregated fund
Not all mutual funds and segregated funds can be held in self-directed accounts. So, if you are thinking of opening a self-directed RRSP or RRIF, you may be forced to sell the segregated fund.
There are no tax implications when selling an investment within a registered account, but non-registered investors may need to consider capital gains taxes. Paying taxes to save fees may be a strategy that pays for itself over time.
Opening a self-directed account
In terms of switching to a self-directed account, you probably do not need to wait until you convert your RRSP to a RRIF to make this change, Leslie. You could open a self-directed RRSP now and transfer your RRSP before you convert it to a RRIF by the end of the year. If you decide to do this, don’t wait until close to year-end—the transfer process could take a few weeks or months. Alternatively, consider converting your RRSP to a RRIF first and then doing a RRIF-to-RRIF transfer.
Your minimum RRIF withdrawal in your 72nd year in 2023 will be based on the year-end balance of your account for 2022.
One thing that I will caution you about: moving from a professionally managed RRSP to a self-directed RRIF at age 71 has its own risks. I do not sell investments, so I am all for self-directed investing in the right circumstances. But becoming a new self-directed investor in your 70s, an age when it can get harder to make investment and other financial decisions, has drawbacks.
If you do take this route, I would encourage as simple a DIY approach as possible, including a low-cost mutual fund or an asset allocation ETF. I also recommend drawing up a power of attorney for property or a similar provincial estate planning document naming someone else to act on your behalf in the event you can no longer manage your investments. And remember, your RRSP beneficiary designation does not automatically carry over to a new RRSP, nor to a RRIF account, when you open it.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.