Multi-Year Guaranteed Annuities: What You Need to Know
When it's time to retire, you're going to have to live off the money that you've been diligently saving and investing. While this if a good problem to have, this...
When it's time to retire, you're going to have to live off the money that you've been diligently saving and investing. While this if a good problem to have, this causes people who are close to retiring to have extra cash sitting in their savings. But, it's only earning a small amount of interest.
As much as you don't want to risk placing your hardearned money into a risky vehicle that might lose value, you also don't want it to just sit there collecting duct either. It's for this reason that MYGAs, or Multi-Year Guaranteed Annuities, are so popular.
How Do MYGAs Work?
In short, an MYGA is nothing more than a fixed annuity that's sold by insurance companies. Usually, these products are offered in terms of three, five, and seven years. These terms are referred to as the guarantee period which is the timeframe during which the company is committed to paying a guaranteed fixed interest rate.
In a MYGA, a lump sum of money is paid the insurance insurance so that it can accumulate interest over the agreed upon term. Just note that depending on the annuity, you may have to pay surrender charges if you need to withdraw money before the accumulation period is over. However, some contracts may provide for penalty-free withdrawals before the surrender period ends.
What happens when the accumulation period ends? You can either cash out the premium and interest earned, or you can renew your policy. It is possible that your interest rate will differ from that which you originally agreed on if you choose to renew the contract.
Another option? You could transfer the funds to another type of annuity. And, if you do this using a 1035 exchange, you will not be subject to a tax penalty.
In order to avoid getting fleeced, always do your research before signing a contract. Insurance companies determine interest rates, so do your homework before committing to a long-term investment like an annuity.
Getting started with an annuity involves consulting a financial planner to determine how much money you are willing to invest. You must then do a comparison shopping exercise by comparing at a variety of highly rated insurance companies to see what their MYGA rates are.
Depending on the carrier, MYGA rates not only vary, they can also change daily. In late-January 2022, the best rate for a 10-year MYGA was 3.25%, and the best rate for a seven-year MYGA was 3.20%. For MYGAs with five-year and three-year surrender periods, the best rates were 3.15% and 2.50% percent.
Generally, the MYGA rate is typically higher than the CD rate, and it also compounds annually. Also, rates tend to be higher on contracts that limit withdrawals.
MYGA Withdrawal Provisions
There's no way around it. MYGAs are subject to surrender charges. As such, if annuity holders wish to cash out their annuity before its term is over, they will be liable for fees.
The surrender period for most annuities ends before you can withdraw money from the annuity without incurring a penalty fee. Starting in the first year, for example, you can withdraw up to 10 percent of your money.
For MYGAs, withdrawal provisions vary depending on the contract. However, you can generally withdraw part of the funds without penalty during the term. This should be clearly specified in the annuity contract.
You may also be able to take money out of your contract in case of an emergency. A hospital bill may be paid from your MYGA, for instance. You may find this more advantageous than taking out a 401(k) loan or withdrawing from your IRA. Nevertheless, before taking money out of your MGA early, keep in mind that a major benefit of your MYGA is that it grows tax-deferred.
MYGAs and Taxes
Again, in the case of a MYGA, interest is compounded annually and deferred from taxation. In other words, taxes only apply when you take the money out, so they can increase wealth exponentially. This is actually similar to investing in an IRA or 401(k), but without the contribution limits.
Be aware that if you purchase an annuity using different types of funds, the tax rules change a little. CNN Money reports that you pay income taxes on principal and interest when you withdraw money from an MYGA purchased with qualified funds, such as from an IRA. And, you'll only pay taxes on the interest earned if you bought an MYGA with nonqualified funds.
At the same time, tax benefits like this are not specific to MYGAs. Traditional fixed annuities, as an example, offer the same benefits.
An MYGA offers similar benefits to other annuities, including:
- Guaranteed income. It is possible to use these as a means of creating a regular income stream during retirement. These are the only financial vehicles that guarantee lifetime income.
- Tax deferral. As opposed to traditional savings products such as CDs and savings accounts, MYGAs are tax-deferred until you begin withdrawing funds.
- Partial withdrawals. Annual withdrawals of up to 10% of the annuity value are usually penalty-free.
One of the benefits that are unique to MYGAs is principal protection. "The market is not going to disrupt the principle," explains Stan Haithcock. "You could peel off interests with some of them. Some with care, or they're guaranteed."
"Inside an IRA, it's a guaranteed interest rate, just like a CD would be outside of an IRA," he adds. "The interest grows and compounds tax-deferred." CDs require that you pay taxes on the interest you earn each year.
"But both are perfect products for principal protection," states Stan." But CD is Multi-Year Guarantee Annuities, are safe money products."
You should include both in your portfolio, he advises. "One is not better than the other; it's just you shop all of them for the highest contractual guaranteed rate for the specific terms."
There are, of course, some features that MYGA owners will miss out on in comparison to other types of fixed and indexed annuities.
The owners of most other annuities are permitted to withdraw 10% of their principal per year, which in is called a "free withdrawal." While you may find an MYGA that offers this feature, others only permit a withdrawal of 5% per year.
There are other MYGA contracts that allow withdrawals of interest only or none whatsoever. In exchange for your money growing at a compounding guaranteed rate each year, you trade off a smaller amount of annuity liquidity.
Those aren't the only disadvantages. The amount of interest you are paid can be reduced if you withdraw money from the accumulation value of an MYGA. And, while this is a safe investment, you won't have growth potential that you could receive from variable or index annuity rates.
MYGAs vs. Traditional Fixed Annuities
Overall, MYGAs fall under the fixed annuity umbrella. However, MYGAs differ from traditional fixed annuities in that their interest rates are guaranteed for a fixed period of time.
More specifically, MYGAs guarantee the interest rate for the entire duration of the contract, which could be for a period of ten years. A traditional fixed annuity may only guarantee the interest rate for part of the contract's term. So, for example, you may buy a seven-year annuity. But the rate may only be guaranteed during the first three years.
MYGAs vs. CDs
Certificates of deposit are often mentioned in the same breath as multi-year guaranteed annuities because of their similarities.
For a CD, you need to tuck your money away for a specified period of time. The CD can be renewed (at the current interest rate) or you can withdraw the original deposit and interest earned upon maturity.
Upon expiration of your contract, you may also be able to renew your MYGA. It is possible that the interest rate will be different from what you originally signed up for. The rate you'll be offered at renewal time may vary from what you've been earning, as it is with CDs.
It's possible to withdraw principal and interest from your MYGA if you decide not to renew it. Again, you may be able to surrender your annuity without being penalized, during which there are no surrender charges. Or, you could use a 1035 exchange to move the funds into a higher-yielding annuity without triggering a tax penalty during that time frame.
There are, however, a number of differences between MYGAs and CDs:
- MYGAs are contracts with insurance companies, whereas CDs are issued by banks and brokers.
- Bank CDs are insured by the FDIC, but MYGAs are not.
- You may be able to make partial withdrawals each year without incurring a tax penalty with an MYGA. Taking money out of a CD before maturity typically incurs an early withdrawal penalty.
- The interest rates on a MYGA may be better than those on a CD.
- The fees on annuities are typically higher than those on CDs, and the growth is tax-deferred, unlike with CDs where you will have to pay taxes on interest every year.
Frequently Asked Questions About Multi-Year Guaranteed Annuities
1. How does an MYGA work?
First, make sure to compare prices from several different insurance companies if you're interested in purchasing an MYGA. Ideally, you should use a broker with a variety of options.
Next, keep an eye on interest rates. You can expect to see interest rates ranging from a little over 1% to over 3.5%. But, it's normal to get a higher interest rate if you choose a long-term loan. And, also choose a term that works for you — usually you can choose any term between two and ten years.
After agreeing to the contract, you'll transfer over a lump sum of money, which can be anywhere between $15,000 and $1,000,000. And, then you just leave it alone until the term is over.
2. Where can I buy an MYGA?
You can purchase MYGAs through an insurance agent or even directly online. However, when buying direct, the interest rate is usually higher. The reason for this is that commissions paid to agents can eat up a customer's rate.
It's possible to purchase an MYGA in a few easy steps due to its simplicity and easy-to-understand features. But, an agent or financial advisor is best suited to help you with more complex annuities, like fixed-indexed or variable annuities.
3. Can I get out of an MYGA if I don't want it anymore?
As long as you are at least 59 ½ years old, MYGAs typically allow you to withdrawal 10% of the cash value of the account per year.
If you want more liquidity, that's possible. But, that comes at a price. In most cases, you will take a lower interest rate in exchange for more flexibility in how you can use the money while it's in the insurance company's hands.
4. What do I do when my MYGA term ends?
A few options are available to you when the MYGA term ends.
If you just want the money, you can take it. Because MYGAs are tax-deferred, you will be subject to taxation.
If you used qualified money that is not taxed yet, such as an IRA or 401k, then both your initial deposit and the interest will be taxed. Taxes are only due on gains if you used money that was not qualified, or money you already paid taxes on.
What if you don't need the money then the MYGA term ends? You can renew the policy if you want. But, you may have a different interest rate. If it's less then the initial interest rate, you can transfer the money into a higher-yielding MYGA.
In order to divide the maturities of MYGAs, you could consider using a laddering strategy. In this case, if you had $150,000 to spend on an MYGA, then you would invest $50,000 annually in years, 3, 4, and 5. It's your choice every year whether you want to take the money or not, though you must reinvest if you don't want to take it. And, if you end up needing some money, you can still access it while still earning some interest on the rest.
5. Who is an MYGA good for?
Most MYGAs are designed for retired or near-retirees. Besides offering a guaranteed fixed rate of return, it can also provide a lifetime income stream in retirement, just like all annuities. But, there's also a minimal amount of risk involved. And, you can have the option to select a timeframe that fits your needs. For example, you could have a 3-year MYGA with limited access to your money as opposed to letting it sit in a savings account that won't accumulate as much.
At the same time, tougher people typically find that stock and bond investment accounts yield better returns.
The post Multi-Year Guaranteed Annuities: What You Need to Know appeared first on Due.
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