A multi-year guaranteed annuity, or MYGA, is very similar to a CD. A MYGA pays a fixed rate of interest and is most appropriate when you need a stable return from a conservative investment.
Any time I mention annuities I try to make it clear that I am not licensed to sell them. Annuities tend to have a bad reputation, but mostly because so many of them have been misused or misunderstood. No doubt, some of that misuse has been caused by salesmen that earned a high commission for pushing them. However, they aren’t all bad. Some annuities are quite useful useful, particularly in a retirement income plan.
My general rule is the simpler the annuity is, the more likely it is to be useful. A MYGA falls into the simple category and can be useful depending on what you need.
How Does a MYGA work?
A multi-year guaranteed annuity is a type of fixed annuity. You purchase a MYGA from an insurance company with a single up-front deposit. In exchange, the insurance company offers you a contract that specifies the term and a fixed interest rate you will earn each year. In this regard it is very similar to a certificate of deposit that you would get from a bank.
MYGAs will usually have a higher interest rate than comparable CDs. Of course, the classic trade-off between risk and return is present here. Because MYGAs are guaranteed by the insurance company the amount you can earn is substantially less than you could earn on non-guaranteed investments. You can get an idea of current rates at Immediateannuities.com.
A potentially significant benefit that a MYGA has over a CD is that the interest earned on a MYGA is tax-deferred. The interest earned on a CD isn’t. You will have to pay income tax on the interest you earn from a CD each year.
You will eventually have to pay taxes on any interest you receive form a MYGA, but only when you take it out of the contract. This provides you with a little more control which could be helpful if you are actively managing your taxes.
Of course, that tax deferral is already happening if you are invested inside a tax-deferred retirement account.
When you buy a CD, what protects you in the case that the bank goes under? Everyone who uses a bank is familiar with FDIC insurance. You see the little plaques sitting on the tellers desks every time you go to the bank. Almost everyone also understands that FDIC insurance protects your deposits in the bank, up to a certain limit. This is one of the key features of our banking system.
So is there anything to protect the money you use to invest in a MYGA? There isn’t a protection at the federal level, as with FDIC for bank deposits. Insurance products are regulated at the state level. Wile states have some safeguards in the place through State Guarantee Associations you shouldn’t rely on that alone in deciding to use a MYGA. A guarantee from an insurance company is only as strong as the insurance company itself. Before you purchase a MYGA, or any annuity, check out the insurance company and make sure it is a reputable company.
MYGA Ladder vs. CD Ladder
Laddering is a very common, and useful, strategy. To build a ladder you stagger different fixed investments with varying ending or maturity dates. You can build ladders with Bonds, CDs, and MYGAs.
Bond ladders are very common in retirement income planning. You can also create an annuity ladder using MYGA annuities. You can use a MYGA ladder in much the same way you would use a bond ladder to provide a known amount of income at specific times.
Suppose you want to lock in a set amount of retirement income starting in five years, and you want to lock in that income for three years. To build your ladder, you would invest in three MYGA contracts each maturing in 5, 6, and 7 years. When the contract ends you would take your investment, which has grown by the contractually fixed rate.