MYGA ladder

MYGA vs CD, and MYGA Ladders

Why You Should Consider MYGAs instead of CDs

MYGAs are good annuities. It is a shame that 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). Also, you can do some asset-liability matching with a MYGA ladder. Advanced stuff; we will learn more about it below!

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 guaranteed by the insurance company.

Note that these are “good” annuities without large expenses. MYGAs are annuities that you buy, whereas Fixed Indexed annuities 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 to a different annuity at the end of the period.

Let’s start with 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). Taxes will be owed if you cash out at the end of the term. This may be advantageous, especially if you are building your bond ladder when you don’t want income!

Say you still have some income from work, but you 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 taxes, but you 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 or life insurance product. With MYGAs, ordinary income taxes will be paid, but you have some flexibility to 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, it is essential to plan to withdraw from a MYGA at the right time.

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 principle 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 into 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 that MYGAs will be specific to your state.

 

Example of MYGAs vs. CDs

Let’s see what MYGAs pay compared to CDs and Treasury Bonds.

MYGA vs CD

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 1-5 year duration, and I have included the average rate and the best rate 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 you are comparing MYGAs vs. CDs, MYGAs pay you quite a bit more currently. There are stiffer early withdrawal penalties with MYGAs vs. CDs, but you can tax defer your income MYGAs. 

Finally, CDs are insured by the FDIC, whereas the issuing insurance company guarantees MYGAs. 

Next, let’s look at a MYGA ladder.

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 a little more flexibility early on, maybe consider CDs for years 3-4. 

Given low-interest rates, it is just hard to consider having a bond ladder right now! Low-interest rates make finding sources of income in retirement planning difficult.

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 are planning 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 likely increase 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.

 

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4 Comments

  1. Good one Dave. Love to see your stuff for us conservative, safety-first retirees out here. Thanks. I bought a 2 and a 3-year in August to replace CDs in the shorter terms of our TIPs bond ladder which as you suggest, are liability-matched against future expenses. Buying process was pretty simple. Agree they are a decent CD alternative. Since this is the first time I have bought these I will be interested to see what happens when they mature.

    • Thanks! Be sure to let us know! I would assume you roll the money back into something else or take it out and use it!

  2. A Question:

    How much weight do you give to the AM Best ratings on MYGA firms?

    It seems to me the ratings have a variable effect on interest rates. Is there a real difference in risk from say A++ to B++? From what I understand they are all state regulated.

    • Right, all insurance products are regulated and insured at the state level.

      I would think the longer term MYGA I was considering, the higher rating I would want. If it was short term, rating might matter less.

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