Question: Every agent I meet with tries to sell me a variable annuity or indexed annuity. All I really want is a fixed rate guarantee. Is there an annuity that actually works like a CD? from Bill in Matthews, North Carolina
Answer: Yes Bill, there is an annuity structure that functions like a CD. That type of annuity in the industry is referred to as a MYGA. MYGA stands for Multi Year Guarantee Annuity, but it is also appropriately referred to as a Fixed Rate Annuity. In other words, there is a contractual guarantee within the policy that is for a certain period of time. For instance, you can buy a 5 year CD (Certificate of Deposit) that has a guaranteed yield of 2.5% for each of the 5 years. As a comparison, you can buy a 5 year fixed rate annuity (MYGA) that has a guaranteed yield of 3% for each of the 5 years. However, there are some specific similarities and differences between CDs and Fixed Rate (MYGA) annuities that you need to be familiar with so that you can make the right product decision for your situation.
Similarities Between CDs & MYGAs
As mentioned previously, CDs and MYGAs both offer a guaranteed fixed rate for a certain period of time. CDs can offer very short terms like less than a year as well as longer term lock ins as well. The shortest term MYGA in most cases is 2 years, with these fixed rate annuities being offered with guarantees as long as 10 years or more. Both CDs and MYGAs have no internal fees that are charged, and each have surrender charges if you take all of your money out of the contract before the specified term ends. If you hold a CD or MYGA to the full term of the contract, then there are no surrender charges to get your money out in full.
Differences Between CDs & MYGAs
The primary difference between CDs and MYGAs is that interest earned on a CD is taxable on an annual basis. With MYGAs, interest earned compounds tax deferred and is only taxed when you take the money out. At that time, the taxation on a MYGA is under the accounting rule of LIFO (last in first out), which means that gains are taxed first and at ordinary income levels.
In addition, CDs are insured by FDIC whereas MYGAs are backed by state guaranteed funds (www.nolhga.com). FDIC and state guaranteed fund backings are not the same, with FDIC coverage being the stronger of the two in my opinion. Also, it’s important to know that an agent cannot legally use the state guarantee fund coverage in their sales presentation. Your decision to own an annuity should be based primarily on the ability of the issuing carrier to back up that specific guarantee.
How to Choose
I typically advise clients that if your time frame is 2 years or less, than a CD or Money Market is probably the best choice for a guaranteed fixed rate. If your time frame is more than 2 years, then a fixed rate annuity (MYGA) might be an appropriate solution. Additional food for thought is that if you need a fixed rate, but want to defer taxes, then a MYGA is your only choice for that specific solution.
What I find is that a combination of CDs and MYGAs both work well in the fixed rate portfolio, and complement each other if allocated properly. So the next time you are looking for a pure fixed rate, consider both CDs and MYGAs as simple and efficient safe money solutions.
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