A CD Annuity, technically called a Multi-year Guarantee Annuity (MYGA), is an insurance product that incorporates the long-term interest rate guarantee of a certificate of deposit (CD) into an annuity, often used as a long-term tax-deferred investement to fund retirement programs. Interest earned on CD-Type Annuities is tax-deferred, allowing the CD Annuity value to grow more quickly than a typical Bank CD offering the same interest rate. CD Annuities are generally regarded as niche annuities that were created to address the concern of some potential annuity purchasers that fluctuating interest rates created too much uncertainty.
Sometimes referred to as Fixed Indexed or Equity Indexed Annuities
Traditionally, Annuities have been classified as one of three investement types. A fixed annuity grows by crediting an interest amount annually at a rate declared by the insurance company. A Fixed Index Annuity, grows by the periodic crediting of interest that is calculated based on the performance of an investment index like the Standard & Poor’s 500 (S&P 500). When the index increases, interest is paid according to a formula based on the index’s gain. A Variable Annuity grows in value according to the actual investment of the principal in securities, which can result in gain or loss of value. When the index decreases, no interest is credited, but the account doesn’t lose value, either. Thus, while annuities are long term in nature, their interest rates fluctuate, resulting in some level of uncertainty for the investor. The CD annuity represents a fourth annuity investement type, one without any fluctuation in interest rates prior to maturity.
The CD Annuity was created to eliminate uncertainty for annuity investors who liked the guaranteed interest rate of a long-term CD but do not like being taxed on interest gains every year. Like a CD, the interest rate of a CD Annuity is guaranteed. Another attractive feature of any annuity is that if the owner dies, the annuity passes immediately to the named beneficiary, usually without having to wait for the probate process. CDs, on the other hand, are considered an asset and their value can be tied up in probate for months.
Differences between CDs and CD-Type Annuities
- Bank CDs are typically issued by banks. As such, they are covered by FDIC guarantees. Fixed annuities are issued by insurance companies, and are not insured by the FDIC. In almost every case, fixed annuity guarantees are subject to the claims paying ability of the issuing life insurance company — it is important that you check the latest financial financial strength ratings of the insurance company before investing any money. Fixed annuities are typically covered by state guaranty funds that protect your investment — $100,000 to $300,000 in most states, and up to $500,000 in states such as New York and Washington.
- Fixed annuities typically offer higher interest rates than bank CDs.
- Fixed annuities and bank CDs are taxed differently. Except if held within a retirement account such as an IRA or 401k, gains on bank CDs are taxed every year; gains on fixed annuities are not, and subsequently your return on a fixed annuity would be greater than a bank CD if the interest rates are equivalent
- Keep in mind that if you cash out of a fixed annuity and you are younger than 59½ years old, the IRS will penalize you by taking 10% of interest gains. To avoid the IRS penalty prior to 59½ years of age, you must roll the money into another annuity. In this regard, fixed annuities should be considered retirement vehicles, regardless of the surrender schedule
- The most competitive fixed annuities typically permit withdrawals of the previous twelve months’ interest, without insurance company penalty. Some allow you to withdraw 10% of premium per year without insurance company penalty. Bank CDs typically do not permit withdrawals without penalties