How to protect long term director benefits as a small business

How to protect long term director benefits as a small business

We live in a business world which is cutthroat and often lacking in respect and loyalty – a very tough environment for small businesses. Keeping together that team which brought your business from nothing to where it is today is vital to your future success. Yes, there will be a time and a place to build on your existing team but every business needs a backbone. It is now time to consider long term director benefits which offer a degree of financial security going forward and an incentive to stay with the business.

Rewarding success not mediocrity

In reality money makes the world go round but small business leaders need to realize that rewarding mediocrity is no recipe for success. You need to focus on those who make your business tick, important cogs in the wheel and those who will be around to enjoy your future success. So, how should you go about rewarding success?

Have you considered segregated funds?

Segregated funds are often mistaken for mutual funds when in reality there are numerous differences and a degree of guaranteed return. Segregated funds are especially popular in Canada with many small to medium sized Canadian businesses looking to reward key directors with long-term incentive schemes.

What are segregated funds and how do they work?

In simple terms a segregated fund investment is classed as an insurance contract with part of the funds used to purchase guaranteed death/maturity payments. The rest of the funds are invested within an insurance contract which holds funds in other traditional investment vehicles. The idea is simple; the guaranteed insurance element will provide a backbone while the investment element should expose the investor to long-term capital appreciation.

We will now take a look at the various attractions of segregated funds and how you can work them into your director benefit schemes.

  • Protecting the principal investment

When investing in a segregated fund you will find that a minimum of 75% of your initial investment is protected with some segregated fund managers offering 100% protection. This means that in the event of the value of your policy collapsing you will still receive a guaranteed percentage of your initial investment – if you hold for the full term. However, there is also the potential to benefit from long-term capital appreciation through your investments held under the insurance contract - traditionally in mutual funds.

How to protect long term director benefits as a small business

  • An important element of tax planning

When looking at rewarding key directors/personnel it is very important to ensure there are no unexpected tax liabilities – this would undo all of your hard earned goodwill! Segregated investments are very popular in Canada for a number of reasons, one of which is the part they play in long-term tax planning. Upon your death the beneficiary named on your segregated fund investment would receive the guaranteed death payment/value of the underlying investments, whichever is the greater. As this investment structure is classified as an insurance policy it would not form part of the deceased’s estate and therefore not incur any form of inheritance tax. Many long-term employees will appreciate not only the potential for long-term capital growth with segregated funds but also the guaranteed elements, especially the guaranteed minimum payment on death.

  • An optimal mix of protection and long-term capital growth

The key to any investment, and indeed any directors benefit scheme, is to minimize losses while maximizing gains. While it would be foolish to suggest that any investment is risk free, there needs to be an element of risk to create an element of return, segregated funds offer an optimal mix of protection and potential for long-term capital growth. The maturity payment is generally guaranteed between 75% and 100% of the principal investment with a guaranteed minimum payment upon death. In order to benefit fully you would need to hold the segregated fund until maturity which tends to be from 10 years upwards.

  • Flexible investment opportunities

As the number of segregated funds in Canada continues to grow we have seen diversification into all areas of investment. This diversification is achieved by using the insurance contract funds to acquire exposure to mutual funds. As a consequence, you will have a choice of investing in particular countries, particular indexes or particular sectors such as real estate, technology, utilities, etc. Some investors may prefer long-term investment in technology shares while others may be a little more cautious and look at general index tracking funds.

  • Reset protected value

One of the main attractions of segregated funds is the protected element which tends to vary between 75% and 100% of the original investment. Many segregated funds will offer what is known as “reset protection” which allows you to reset the level of protection afforded to your investments. Let us assume that you invested $50,000 and within three years your fund was worth $75,000. The original protection of between 75% and 100% equates to a protected element from $37,500 up to $50,000. Pressing the “reset button” you can effectively reinvest your funds at the $75,000 level with the protection increased to between $56,250 and $75,000.

How to protect director benefits as a small business

When pressing the reset button it is important to note that you would also reset the term, which is traditionally between 10 years and 25 years. It is only by holding the segregated fund investment for the full term that you would benefit from the protection. If the investment was redeemed prior to the full term there would be redemption fees and no protected element - you would simply receive the market value of the underlying investments at the time.

Management fees

There is no one size fits all when it comes to segregated funds, mutual funds or any other type of pooled investment. In general you would expect to pay higher management fees for segregated funds compared to mutual funds, which in some ways reflects the protected element. There is still competition amongst segregated fund managers, with varying management fees, although you will tend to find they take a more conservative approach to long-term investment. Segregated investments are not short-term speculative investment vehicles, they are structured to allow investors to benefit from long-term capital appreciation with varying degrees of protection. Perfect for director benefit schemes!

Valuing your employees

The business world is extremely competitive and entrepreneurs showing flare and an ability to build businesses are often in demand. Money does talk in the modern world, of that there is no doubt, but by bringing valued employees/directors into your long-term company benefit scheme at a relatively early stage often sets the tone going forward. Loyalty breeds loyalty and while no employer would like to stand in the way of those headed for greater things, you will want to hold onto them for as long as possible!

The use of segregated funds, partially or fully funded by the company, illustrates confidence in individual employees. As the funds are protected to a certain extent, and this protection can be reset at higher levels, this creates a degree of stability. Even in the event of a stock market crash the employee knows that the benefit scheme investment will still retain a relatively high guaranteed element assuming there have been resets along the way.

Planning for retirement

It is all good and well chasing highflying technology stocks when the market is strong but there will certainly be dips along the way. You tend to see that technology stocks are hardest hit in a sustained market fall because they rarely have profits to fall back on and tend to depend on hope value in the early days. As a consequence, even relatively modest average annual appreciation in director benefit schemes can reap significant rewards in the longer term. It may be possible to insert certain conditions into a director’s benefit scheme so that the longer they remain with your company the greater the rewards. Everyone likes an incentive?

benefits as a small business

Leadership and team building

Many larger companies can simply open their cheque books, tempting fresh talent over with promises of untold riches and numerous long-term benefit schemes. When heading up a relatively small business the key is leadership and team-building. In this environment you will tend to have a relatively small core of key employees who drive certain areas of the operation. Keeping these people on board, incentivizing them and inviting them to join long-term benefit schemes not only shows your confidence in them but also rewards them in cold hard cash.

Long term director benefits summary

More and more Canadian entrepreneurs are looking towards segregated funds as a means of rewarding and retaining key personnel/directors on a long-term basis. The fact that segregated funds offer a degree of protection, guaranteed death and guaranteed maturity payments, while benefiting from long-term capital appreciation on the underlying mutual fund investments, offers the best of both worlds. Even if you fully expect some of your key personnel to go on to “bigger and better things” it is still worthwhile trying to retain them for as long as possible and benefit from their skills!


While money talks in the world of business there are still ways and means of instilling loyalty into your workforce which works both ways. Long term director benefits have successfully allowed many businesses to retain key personnel. How does your company reward key personnel?

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