I think everyone knows that a CD is a type of contract issued by banks or brokers. An annuity is a type of contract with an insurance companies. Both are regulated. Annuities are regulated by the state insurance commissioner in each state.
There are many flavors of annuities. One types is very similar to a certificate of deposit (CD). This is called a Multiyear Guaranteed Annuity or MYGA. I think this type is a valid consideration as a CD replacement.
Key points:
CD's are backed by the FDIC up to $250k per person per account.
MYGA's are not backed by the FDIC. Since annuities are regulated by the states, MYGA's are backed by the "State Guarantee Fund" of each state. In Florida, this guarantee is $250,000 per person per account. The Guarantee Fund is funded (this is a legal requirement) by the insurance companies registered to do business in Florida.
A MYGA is a type of fixed annuity that provides a pre-determined and contractually guaranteed interest rate for a specified period of time, most commonly 3-10 years.
It's easiest to understand if I give an example:
Fidelity is currently offering a 5 year MYGA from Massachusetts Mutual Life that pays 1.9%. During the 5 years your interest accrues tax deferred. Taxes on interest are not due until you withdraw your money.
At the end of 5 years you are entitled to withdraw the entire principle plus interest in one lump some. You will owe taxes on the accrued interest at this time.
There are steep penalties if you withdraw money sooner than 5 years. If you do not want to take a lump sum at the end of the period (5 years in this case) you are allowed to roll it over (with taxes on accrued interest continuing to be deferred) in another annuity.
Massachusetts Mutual is rated A++ by AMBest. Companies rated A++ have had less than a 0.1% default rate in the last 20 years in the USA. And when there has been defaults, in almost all cases the state guarantee funds have been able to cover the amount guaranteed (usually 250k per state)
So this Massachusetts annuity offered by Fidelity is quite similar to a CD.
1) You can purchase this with a maturity of 3 to 10 years.
2) The interest rate is fixed at 1.9% for the period of 5 years for this annuity contract.
3) At the end of the contract, you are able to receive a lump sum payment of the original principal + accrued interest.
4) Your principle is backed up to $250k by Florida's Guarantee Fund
5) The interest rate you receive is exactly as stated. The agent who sells the annuity to you is making a hefty fee (usually 1 to 2%), but that fee is already calculated into the agreed upon interest rate. So there are no surprises.
6) You can buy these for your IRA, Roth or personal account.
Some difference from CD's
1) Interest grows tax deferred until you receive it at the end of the contract
2) It is not backed by the FDIC
3) Typically, this type of annuity pays a higher interest than CD's (arguably because the State Guarantee Backing is not as strong as the FDIC)
4) There are age restrictions ... This particular annuity will only be sold to you if you are under 85 years.
I'm in no way pushing this type of annuity. But they do offer a better interest rate than you can currently earn on CD's. It's important to understand that the default rate is much much higher as you move from A++ to B++ rated insurance companies. The 250k state backing is very good ... but it's not the FDIC
And I personally would not touch annuities tied to stock indexes. And I have no interest in "annuitizing" the return (receiving payments for life) in this low rate environment. For that reason I like the lump sum payment at the end of the contract.
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