The world of financial planning is complicated enough, but when options are similar, it can grow even more confusing. Long considered alternatives to one another, certificates of deposit (CDs) and multi-year guaranteed annuities (MYGAs) have many similarities that often confuse those comparing the two. Here, we will compare and contrast the major similarities and differences of these products. Understanding their fundamental functions will be a major first step in making your purchasing decision.
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Annuities and certificates of deposit are often sought out by those with a low tolerance for risk. Both can be sensitive to the investment markets, but many purchase them with security and a strong yield in mind.
Multi-year guaranteed annuities (MYGAs) are a type of fixed annuity product with a fixed interest rate designed to provide an income throughout retirement. While fixed annuities have a fixed interest rate, that rate may only stay consistent for the first few years of the contract. With an MYGA, the rate is held for the entire length of the term, which tends to be longer than other fixed annuities.
A certificate of deposit, while also intended to provide some financial stability, has more of a short- to medium-term focus in comparison to MYGAs. CDs are also a savings product issued through a bank and may have higher interest rates than other types of savings accounts. Regardless, this is still a very safe and secure option when making financial decisions for retirement.
Like a CD, an annuity can also be purchased for a specified term, often crediting a guaranteed rate of return during the specified period. Each of these products can be purchased as a qualified account (IRA), meaning there are certain tax benefits, such as tax deferral on withdrawals.
At a glance, MYGAs and CDs are very similar. They both require an upfront payment which accumulates interest at a guaranteed rate. However, once you begin to look at the finer details, you’ll notice some important differences. These differences can be determining factors when making a selection between the two products.
One differentiator between MYGAs and CDs is where they are available. MYGAs are products offered by insurance companies and require an up-front investment to act as a premium payment.
CDs, on the other hand, are a type of account offered by banks, much like other types of savings accounts. The initial money put toward a CD is a deposit to the account and can build overtime depending on the interest rate.
Certificates of deposit are insured by the FDIC, giving the owner an additional amount of security for their funds. They insure these accounts dollar for dollar and are the most secure contract one could have. However, according to the FDIC’s website, if an interested party wanted to purchase a CD that exceeded $250,000 in value the FDIC would not insure the full value of the contract.
In contrast, a multi-year guaranteed annuity is backed by the financial strength of whichever company it is purchased from. Normally, a company will have reserves set aside to ensure they can properly pay all of their contract owners in the event of the company failing. Overall, an annuity’s security pales in comparison to a CD’s (as long as the funds are under $250,000), but can still be considered reliable.
Both MYGAs and CDs help build financial stability, but how that money is distributed varies significantly between the two. With MYGAs, policyholders pay a lump sum premium to an insurance company that will grow overtime as it earns interest. When the term ends, there is an option to annuitize the money, meaning it can be distributed in regular installments as a form of income through retirement.
Much like a savings account, you have the option to withdraw from your CD, though it is recommended to leave the money alone for as long as possible. The longer a balance has to sit in the account, the more it will grow its interest. Plus, many banks offer higher interest rates for longer terms. When the term is up, you will simply receive your balance back, plus any interest earned.
MYGAs hold longer term lengths than CDs. Most often, MYGAs are available in periods between three and ten years while CDs are distributed in monthly increments. In some cases, CDs have a term length of up to three or five years, though that is uncommon.
MYGAs, being the more long-term option, allow the money from the premium payment to accumulate more interest over a longer period of time in comparison to a CD. However, it will be important to consider how long you are able to leave your money in an account in order to meet your financial goals.
Both MYGAs and CDS offer fixed interest rates, but the term length may be an impeding factor. Typically, longer term lengths have higher interest rates, meaning MYGAs tend to provide a better rate of return.
For CDs, banks may offer a higher interest rate if you opt for a longer term. When comparing the two products, MYGAs tend to have a higher rate, though it’s important to keep in mind that interest rates are constantly changing.
Many people looking for income in retirement turn to MYGAs for their tax-deferral features. The money associated with MYGAs will only be taxed when the payout is received. Since income during retirement tends to be lower, this can lead to lower tax payments.
Unlike annuities, earnings on a certificate of deposit are taxed at the end of each year, lowering the amount the interest can compound on. CDs can be tax-deferred, if they’re opened as an IRA, but annuities will almost always** be tax-deferred regardless of the contract’s qualification.
Both MYGAs and CDs can provide some financial security later in life, but that doesn’t mean they’re suitable for everyone. To help you choose the right product, it’s always best to sit down with a financial adviser or independent insurance agent. In the meantime, here are a few points to factor in when weighing the two products.
Though MYGAs and CDs are secure savings options, it’s important to evaluate their risks when determining which type of product is right for you. If you have a low-risk tolerance, then either product would suit you since the balance from each account is guaranteed to grow.
Both multi-year guaranteed annuities and certificates of deposit have options once the initial term is up. CDs will usually allow the owner to take the funds in a lump sum or renew the CD for a new term, while an annuity will normally provide the owner with the same amenities plus the ability to leave the funds.
So, when weighing the differences between MYGAs and CDs, you’ll need to consider how long you are able to leave the money in the account. If you can contribute a lump sum premium for five or ten years, then an MYGA may be the way to go. If you are looking for a shorter term savings option, you might be more included to open a CD with a bank.
The most compelling argument for purchasing an annuity is its tax-deferred status. Taxation doesn’t occur until after the funds are withdrawn. So, how does that benefit the purchaser of the product? It benefits the consumer by utilizing compound interest (interest on interest), which allows the contract to grow at a much faster rate.
Though you’ll benefit from either an MYGA or a CD if you leave the account untouched, you still have the option to withdraw if needed. It tends to be easier to withdraw from a CD since MYGAs may have withdrawal penalties, depending on the insurance provider.
If you are a younger individual looking for a low-risk product, a CD may be right for you. The FDIC’s dollar for dollar guarantee and a CD’s modest interest rate are good for those looking for a greater amount of security and less growth potential. Younger individuals tend to be more attracted to these products, as they are not subject to the IRS’s excise tax (unless purchased as an IRA).
If you are closer to retirement, looking for higher yield options with more liquidity and more growth potential, a fixed annuity may be right for you. The annuity’s tax-deferred status and its ability to accrue interest after the guaranteed term, gives a purchaser a secure place for their money, while maximizing the growth potential of their funds. There may have been a time where CDs were the top product on the market, but now fixed annuities have emerged as a powerful alternative for those looking for new avenues.
ELCO Mutual has annuity and life insurance options available to help you meet your financial goals later in life. It’s never too early to begin planning for the future, so reach out to one of our independent insurance agents to learn more about MYGAs today!
**Annuities opened by entities will not be tax-deferred. For example, if an annuity is opened by a company, like ELCO Mutual, it will not be tax-deferred. The information presented above is for informational purposes only. The descriptions of the product’s rates only include fixed versions, not variable. Product features may vary company to company. If you are interested in either of the products listed above, please contact your local financial advisor for more information.