Comparing multi-year guaranteed annuities and CDs for retirement savings

A multi-year guaranteed annuity, or MYGA, is a type of fixed annuity that provides a fixed rate of return for a predetermined period. When you purchase a MYGA, you make a single lump-sum payment to an insurance company, and in return, the company guarantees a specific interest rate for a contract term that can range from two to 10 years, sometimes longer. At the end of the guarantee period, the annuity owner has several options. They can choose to renew the contract for another guarantee period at the then-current interest rate offered by the insurance company, transfer the accumulated funds to another annuity product or withdraw the entire amount (subject to any applicable surrender charges or penalties).

The primary appeal of MYGAs lies in their simplicity and security. The interest rate is guaranteed, so you know exactly how much your money will grow during the term of the annuity, independent of market fluctuations. This makes MYGAs particularly appealing to conservative investors or those who are nearing retirement and want to reduce risk in their investment portfolios.

When considering low-risk investment options for long-term retirement planning, multi-year guaranteed annuities (MYGAs) and certificates of deposit (CDs) are often compared. Both offer fixed interest rates and provide a stable, predictable return on investment. However, there are several key advantages to choosing a MYGA over a CD, making MYGAs a more attractive option for many investors. Those advantages include:

• Higher interest rates. One of the most significant advantages of MYGAs is that they often offer higher interest rates compared to CDs, especially over longer contract terms. This is because insurance companies can invest the funds in a wider range of securities, allowing them to potentially earn higher returns and pass those benefits on to the annuity holder. In contrast, banks offering CDs have more limited investment options and are subject to different regulatory requirements, which can result in lower interest rates.
• Tax-deferred growth. Another major benefit of MYGAs is their tax-deferred growth. Unlike CDs, where the interest income is taxable annually and must be reported on your tax return each year, the interest earned in a MYGA is not taxed until you withdraw the funds. This tax deferral allows your money to grow more quickly over time, as the interest compounds without being reduced by taxes. Additionally, you can strategically plan your withdrawals to coincide with a time when you might be in a lower tax bracket, such as during retirement, potentially reducing your overall tax liability.
• Longer terms. MYGAs are available in longer terms than typical CDs, which can be advantageous for long-term retirement planning. While CDs are commonly offered in terms ranging from a few months to five years, MYGAs can have terms of up to 10 years or more. This allows you to lock in higher interest rates for extended periods, providing a more stable and predictable income stream. Longer terms can be particularly beneficial when interest rates are expected to decline, as you can secure a higher rate for a longer period.
• Principal protection. Both MYGAs and CDs offer principal protection, meaning your initial investment is safeguarded. However, MYGAs are backed by the financial strength and claims-paying ability of the issuing insurance company, while CDs are typically insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per insured bank. While both options provide a high level of safety, it's important to research the financial stability of the insurance company when considering a MYGA.
• Lifetime income option. Some MYGAs offer the option to convert the annuity into a lifetime income stream after the initial guarantee period. This feature can provide a reliable source of income throughout retirement, helping to mitigate the risk of outliving your savings. CDs do not offer this option, as they simply return the principal and interest earned at maturity.

Despite the numerous advantages of MYGAs, there are some situations where a CD might be a more suitable choice:

• Short-term savings goals. If you have short-term savings goals and need access to your funds within a few years, a CD with a shorter term may be more appropriate. MYGAs typically have longer terms and may impose surrender charges if you withdraw funds before the end of the contract period.
• Simplicity. CDs are generally less complex than MYGAs, with fewer options and variables to consider. If you prefer a more straightforward investment option without the need to compare features like surrender periods, payout options and rider benefits, a CD may be a better fit.
• Immediate access to interest. With a CD, you can typically withdraw the interest earned without penalty, although this may vary depending on the specific terms of the CD. MYGAs, on the other hand, often require you to wait until the end of the surrender period to access the accumulated interest without incurring charges.

For long-term retirement planning, multi-year guaranteed annuities offer several compelling advantages over certificates of deposit. These include higher interest rates, tax-deferred growth, longer terms, principal protection and the potential for lifetime income. However, CDs may still be a suitable choice for shorter-term savings goals or for those who prefer a simpler, more easily accessible investment option. Ultimately, the choice between a MYGA and a CD depends on your individual financial situation, goals and risk tolerance. It's essential to carefully consider your options and consult with a financial professional to determine the best course of action for your unique circumstances.

MYGAs have several distinctive benefits when compared to other types of annuities:

• Guaranteed return. Unlike variable annuities, where returns depend on market performance, MYGAs provide a fixed return, which eliminates market risk.
• Simplicity. MYGAs are simpler and more straightforward than indexed or variable annuities, which often involve complex fee structures and investment choices.
• Cost. Generally, MYGAs have lower fees than variable annuities, as they do not require management of investment portfolios or frequent trading.

Incorporating MYGAs into a retirement income plan can provide several strategic benefits:

• Stability. MYGAs add a stable element to a retirement portfolio, which is particularly valuable in volatile market conditions.
• Income laddering. By staggering the purchase of MYGAs (a strategy known as an annuity ladder), retirees can create a consistent income stream while potentially benefiting from different interest rate environments.
• Principal protection. MYGAs provide principal protection, which ensures that the invested capital is not exposed to market downturns, making them a safe component of a retirement plan.

While MYGAs are considered safe investments, they do carry some risks:

• Liquidity risk. MYGAs often come with surrender periods during which large fees are charged for early withdrawals, which can make accessing funds expensive and inconvenient.
• Inflation risk. The fixed returns may not keep pace with inflation, potentially eroding purchasing power over time.
• Credit risk. There is always a risk that the insurance company issuing the annuity could face financial difficulties, although this risk is minimal with highly rated companies.

The growth of investments within a MYGA is tax-deferred, meaning you won't pay taxes on the interest earned until you make a withdrawal. This can be a significant advantage, allowing your investment to grow faster than it would in a taxable account. However, upon withdrawal, earnings are taxed as ordinary income, which could be higher than the capital gains tax rates applicable to other investment incomes.

Despite their benefits, MYGAs have some drawbacks:

• Interest rate risk. If interest rates rise after you purchase a MYGA, you could be locked into a lower rate.
• Surrender charges. Early withdrawal penalties can be steep, making it crucial to plan carefully to avoid accessing funds prematurely.
• Flexibility. Once you commit to a MYGA, you lose some flexibility in terms of adjusting the terms or tapping into the funds for unexpected needs.

Multi-year guaranteed annuities offer a mix of stability, predictable growth and tax advantages, making them a valuable component of a comprehensive retirement income strategy. However, like all investment choices, they work best when tailored to individual financial situations and goals. Considering the benefits and risks associated with MYGAs can help you decide if they are the right tool to help you achieve a secure and reliable retirement.