In today's article, I will discuss the ins and outs, benefits, and disadvantages of Certificates of Deposit (CDs) and Multi-Year Guaranteed Fixed Annuities (MYGAs).
For over a decade (from 2009 through 2021), many investors dismissed these investments because the interest they could earn was almost laughable. However, things have changed! Since the end of 2021, interest rates have increased dramatically on virtually all interest bearing investments. As a result, the interest you can earn on your “safe” money through investments like CDs and annuities has more than doubled. By the end of this article, you will better understand when and how you can use each of these investments to maximize your financial well-being, improve your retirement, and keep your money working hard for you.
Certificates of Deposit (CDs)
Certificates of Deposit are fixed-term deposits offered by banks or credit unions. They are considered low-risk investments and appeal to conservative investors looking for a safe place to park their money. Here's how CDs work:
- Term Length: CDs have a predetermined term length, typically ranging from a few months to several years. Historically, the longer the term, the higher the interest rate tends to be. But in the current environment, short-duration CDs pay similar rates to long-term CDs.
- Fixed Interest Rates: CD interest rates are fixed for the duration of the term. This provides predictability and stability in earnings, regardless of fluctuations in the market.
- FDIC Insurance: CDs offered by banks are usually insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor, per bank. This insurance mitigates the risk of losing your principal investment.
- Limited Liquidity: One drawback of CDs is their limited liquidity. Withdrawing funds before the term's end might incur penalties, which can eat into your returns.
Multi-Year Fixed Annuities (MYGAs)
Multi-Year Fixed Annuities are insurance contracts that offer a fixed interest rate over a specified period, usually between three and ten years. Annuities, while relatively low-risk, are often used as retirement income tools due to their ability to provide a guaranteed interest rate and/or a steady stream of income payments. Here's how Multi-Year Fixed Annuities operate:
- Fixed Interest Rates: Similar to CDs, MYGAs offer a fixed interest rate for the contracted period. This feature ensures stable and predictable returns.
- Tax-Deferred Growth: One of the main advantages of annuities is their tax treatment. The interest earned within an annuity is tax-deferred until withdrawals are made, potentially allowing for greater accumulation over time.
- Lifetime Income Option: Annuities offer the option to convert your accumulated savings into a guaranteed stream of income that can last for the rest of your life, kind of like a pension, addressing longevity risk.
- Surrender Charges: Annuities often have surrender charges if you withdraw funds before the contract's term. These charges gradually decrease over time and are intended to discourage early withdrawals.
Comparing CDs and Multi-Year Fixed Annuities
- Risk Tolerance: CDs provide a little more safety than MYGAs primarily due to being FDIC insured. Although annuities are not FDIC insured, they are generally considered safe investments, especially when purchased through large, highly-rated insurance companies. Also, most states offer protection for annuities through a life and health guarantee association. I would not consider this protection as strong as FDIC, and it varies from state to state, so it is advisable to check your state’s rules. Additionally, before purchasing an annuity, I suggest you check their financial ratings with at least one rating agency. AM Best, Moodys, Fitch, and Standard and Poors are the four main ratings agencies. Regarding MYGAs, I stick with companies that are A- or better with AM Best. You can check their website when evaluating a company https://ratings.ambest.com/.
- Purpose: CDs are usually considered for short-term goals or emergency funds due to their shorter durations. Annuities are more suitable for long-term financial planning, especially for retirement. In my experience, MYGAs pay higher interest rates than CDs, especially when looking at longer terms like five years or more.
- Liquidity: Typically, the penalty for cashing in a CD prior to maturity is substantially less than cashing in an annuity prior to maturity but annuities generally allow for more accessibility to funds prior to maturity. For example, many annuities will allow you to withdraw portions of your policy value each year without a penalty prior to maturity. This is not true for all annuities, so it is important to confirm the withdrawal features prior to purchasing a CD or annuity.
- Tax Considerations: Annuities provide tax deferral benefits, potentially resulting in higher accumulation over time. However, withdrawals from annuities are generally subject to income tax. It is important to note that this tax benefit does not apply to retirement accounts like IRAs and Roth IRAs, as these accounts already enjoy tax benefits.
Both Certificates of Deposit and Multi-Year Fixed Annuities have their merits, catering to different financial objectives and risk tolerances. CDs provide stability, low risk, and short-term options for liquidity, making them suitable for short-term goals. On the other hand, Multi-Year Fixed Annuities offer a blend of security and potential growth, often appealing to individuals planning for retirement and seeking a steady income stream. Before making a decision, carefully assess your financial goals, risk tolerance, and timeline, and consider seeking advice from a fiduciary financial professional to ensure your investment aligns with your overall strategy.
Written by Brandon Carter
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.