Why You Should Consider MYGAs instead of CDs in a CD Ladder
MYGAs are good annuities. Annuities have a bad rap. There are, however, good annuities that the advanced investor should consider.
A MYGA (Multi-Year Guaranteed Annuity) may have a place as a bond-alternative or as a place to put money that you plan on annuitizing in the future (instead of funding a deferred index annuity now).
Sometimes called “fixed rate annuity” or “CD-type annuities,” MYGAs have a 3-10 year deferral and then pay out a lump sum depending on the contract.
Note that these are “good” annuities without large expenses. MYGAs are annuities you buy, whereas Fixed Indexed and Variable Annuities are SOLD to you (with high fees and pressure).
Of course, there are surrender charges if you need your money sooner than the contract expires. MYGAs are accumulation annuities. Therefore, you can cash out or 1035 exchange for a different annuity at the end of the period.
Let’s start with the taxation of MYGAs and then go from there!
Taxation of MYGAs
Taxes for MYGAs are complicated, as is the case for most annuities.
Growth is tax-deferred (as opposed to a CD, where you pay as you go). If you cash out at the end of the term, taxes will be owed. This may be advantageous, especially if you build your bond ladder when you don’t want income!
Say you still have some income from work but want a bond ladder, or you are trying to keep your income low for ACA Premium Tax Credits. You can pick bonds or CDs and pay ordinary income tax as you go or defer paying until you cash in MYGAs. You will still pay ordinary income tax but can pay when you decide the time is right with a MYGA.
If the time is not right to pay the taxes, you can do a 1035 exchange into another annuity. With MYGAs, ordinary income taxes will be paid, but you can choose when you pay them!
In addition, it is also important to note that there is a 10% penalty if you are younger than 59 and a half when you take the growth. Thus, planning to withdraw from a MYGA at the right time it is essential.
How MYGAs Work
MYGAs are “fixed annuities” with a contractually guaranteed fixed interest rate for two to ten years. If you are looking for CD-like products, MYGAs are a strong contender.
In exchange for your premium payment to an insurance company, you get the return of principal plus a guaranteed fixed interest rate for a specified length of time. Depending on the contract, the contract can roll over to another contract (with a different interest rate) if you don’t withdraw the money at the end of the term. If you “need” the money before the end of the contract, there are surrender charges (as there are penalties with CDs if you withdraw the money early).
Since MYGAs are “good annuities,” you can 1035 exchange them for other insurance products. MYGAs are accumulation annuities (not meant to be annuitized for income).
You can use pre-tax (IRA) or after-tax money. If you have a fixed income fund in your pre-tax bucket, you might be better off using that (depending on the interest rate).
MYGAs are mostly for pre-retirees and retirees with a low-risk tolerance. If you’ve taken the RISA, the quadrant to consider MYGAs is the left, left upper. This means you score high on safety-first and moderately high on optionality. If you are more commitment (rather than optionality-based), SPIAs and DIAs are more appropriate.
Finally, remember that insurance is regulated at the State level, so MYGAs will be specific to your state.
Example of MYGAs vs. CDs
Let’s see what MYGAs pay compared to CDs and Treasury Bonds.
Rates for MYGAs, CDs, and Treasury Bonds
Above, you can see MYGAs, CDs (average), CDs (Max), and Treasury Bonds in comparison. Note that a MYGA pays 2% up to 3.25%, depending on how long you hold it. CDs are shown for a 1-5 year duration, and I have included the average and best rates available. Treasury rates are shown for 1,2, 3, 5, and 10-year intervals.
MYGA rates are found at immediate annuity dot com, and these sites are used for treasury and CD rates: Treasury rates
As you can see when comparing MYGAs vs. CDs, MYGAs pay you quite a bit more. There are stiffer early withdrawal penalties with MYGAs vs. CDs, but you can tax defer your income MYGAs. I don’t want to give any specific recommendations, but you can google current MYGA prices or the like and find several websites that give current rates.
Finally, CDs are insured by the FDIC, whereas the issuing insurance company guarantees MYGAs.
Next, let’s look at a MYGA ladder.
So, let’s look at a sample of today’s rates and think about a ladder. If you are committed to having a bond ladder, should you consider adding a MYGA as a rung? Or, maybe, a MYGA ladder instead of a bond ladder?
Above, you can see current rates for MYGAs and recent CD and Treasury rates. Of course, there are special deals for CDs, but you are more likely to get closer to the average than the max.
For 7 or 10 years, you might consider a treasury. TIPs might be an option if you are worried about inflation in the mid-term. For years 5-7, MYGAs might be a consideration. Since you want more flexibility early on, consider CDs for years 3-4.
Where do MYGAs fit on a Bond Ladder?
Instead of a bond ladder, consider a MYGA ladder. This is especially true if you need to tax-defer the income from this investment or plan on annuitizing the investment anyway.
Say, for example, you are interested in a SPIA in the future. You might put away money you plan on spending on the SPIA in the future in a MYGA. Then, when the time comes, do a 1035 exchange into the SPIA and defer paying the taxes until you recognize the income in the SPIA!
On the other hand, look at treasuries, CD, and MYGA rates if you are fixated on a bond ladder. Using a MYGA in a few rungs will increase your diversification and return slightly. Of course, the trade-off is more complexity as you are dealing with a contract from an Insurance Company. There is also the deferral of taxes and the penalty for early withdrawal.
Because MYGAs are good annuities that you must buy (rather than having them sold to you), there are plenty of online sites where you can go and see current rates.
When you compare MYGAs vs. CDs, you can see a clear winner. If you plan on building a bond ladder, consider adding MYGAs as a rung or just a MYGA ladder.
There are tax benefits to consider, but there is an increase in complexity as well.