CD Type Annuities - Good Alternative To Today's CDs?

Ken Tumin | Sep 13, 2012 | 5,921 posts since 2009

A reader forwarded me some info she received on fixed annuities. She has two fixed annuities with features very similar to CDs (often called CD type annuities), and she has been happy with these. Below are a few pros and cons of CD type annuities. Do you know of other pros or cons? Have you had experience with these?

Pros

Rates are a little higher than CDs with similar terms
Interest is tax deferred

Cons

Features are not as transparent or simple as CDs
Not FDIC insured, Only guaranteed by insurance company
Insurance reps often push other annuities that are more questionable

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Answers

Wil | Sep 13, 2012 | 242 posts since 2010

I think the whole point in investing in "CD type" annuities is not to withdraw funds early, in which case the surrender charges wouldn't really matter. Remember, banks and credit unions also have "early withdrawal penalties" as well, and as in the case of Fort Knox FCU, they can apparently change the terms of the EWP on existing CDs at will. Don't invest funds that you might need before maturity, or for an emergency (hence, the importance of having a liquid "emergency fund"), in CDs or "CD type" annuities. But for some investors, in certain circumstances, they can be an attractive investment. My father had a single-premium, fixed-rate "CD type" annuity with ING that paid him 6.25% interest for 10 years! An initial $35K investment ended up being worth almost $60K after ten years! It was one of the smartest investments he had ever made! Alas, unfortunately, good things come to an end, as this annuity did in March 2012. By the way, many annuities allow the withdrawal of accrued interest without surrender charges. My Dad has another annuity, earning a little over $3K per year in interest, that annually sends him a check in the amount of the accrued interest every March.

Rosedala | Jul 4, 2013 | 9 posts since 2010

Hello Wil, and I realize that this thread is 3 years old and perhaps not read by you and the other members, but I wanted to thank you so much for your articulate description of the benefits of CD-Type Annuities.. I couldn't have done it as well and as thoroughly as you did. And, of course, the key word is "CD-Type"!

I've been using them for years now, the first one was for only 4 years and I was SO sorry that it matured. I've had several others too and none of them disappointed me in the least. I still have one due in October this year at 5.05% (I feel like crying) and 2 in 2017 at 5.66%. You have to buy them through an agent which you can pick, who gets 1 or 2% fee and does all the paper work, etc. The insurance companies won't sell you directly nowadays (I bought them directly years ago). I think a mere 2% for the agent should not hurt being we get such competitive interest rates...I know of no other fees or expenses at all.

Now, the other side of the coin: about 23 years ago when I was young (well, young-er) and stupid for listening to the bank manager who sold me an annuity without me knowing a thing about them at the luring interest of 8.75%! Of course I fell in the trap and realized too late I was tied up for life. I further learned that withdrawing EVEN on maturity and EVEN if consenting to annuitize...I'll be paying a penalty. However, they committed themselves on the contract that it "will never go under 4%" so now I'm enjoying it but no doubt they'll get it all back through the penalty. lol!

Rosedala ;o)

Wil | Sep 13, 2012 | 242 posts since 2010

Cons: Not FDIC insured, Only guaranteed by insurance company

It is true that "CD type" annuities are not FDIC insured, but to say that they are only guaranteed by the insurance company isn't entirely accurate. As an insurance product, they are guaranteed by your state's "guaranty fund." In NJ, for example, the maximum liability for the present value of an annuity contract is $100K, while in neighboring NY it is $500K. In no state (including DC and PR) is it less than $100K.

CTM | Sep 13, 2012 | 62 posts since 2010

In California, which I believe is unique, the "guarantee" is 80% of present value, not to exceed $ 250K.

CONS: (Pun intended) -

Many (most/all) of the annuities have huge starting surrender charges (10% is huge). The charges generally decline over the life annuity, but I have not seen a single one where they are eliminated.

Many of the annuities have MVA (Market Value Adjustment) clauses. If interest rate rise and you withdraw funds, you may also be charged for the difference in interest rates. The reverse is also true, but interest rates cannot go much lower. Once again, interest rate risk is passed to the buyer.

CTM | Sep 14, 2012 | 62 posts since 2010

I believe some context is important.

In March of 2002, the yield on 10 year paper was (from the Fed's H.15 monthly statistics):
Treasuries ~5.250%, AAA corporate ~6.750% and investment grade corporate ~8.125%.

In August of 2012, the yield on 10 year paper was:
Treasuries ~1.625%, AAA corporate ~3.500% and investment grade corporate ~5.000%.

Simply for comparison, the following is current data for the ING Guarantee Choice 10, (low band < $ 75K). While this may not be the exact annuity referenced, it is likely very similar.

Yield to surrender 1.50%, sales commission 3.25%, 10% yearly withdrawal without penalty, first year surrender charge of 9% decreases 1% per year. In most states, this annuity is also subject to a Market Value Adjustment [MVA] for early withdrawals exceeding 10% of the current accumlated balance. I believe that S&P's credit rating for ING's annuity and insurance products is A- or investment grade (there are many ING businesses with varying credit ratings).

I agree that the point in investing in a MYG annuity is not to withdraw the money, but it is sometimes a necessity. That is why there are many discussions of EWP on DepositAccounts.

I also agree that many (most/all) MYG annuities allow for yearly withdrawal of accumulated interest, but so do virtually all CDs.

Wil | Sep 15, 2012 | 242 posts since 2010

CTM: I get your point, but some additional context. Bond ratings can change before the bond matures, so there is no guarantee that your AAA corporate, or even investment grade corporate, will remain so. For example, I had an investment grade bond with CIT Group, which fell to junk, and then defaulted. Fortunately, the restructuring of CIT debt turned out to be relatively friendly to the bondholders. You'll probably say that the insurance company's credit rating can also change, and you would be right. But, unlike bonds, my Dad's single-premium, fixed-rate annuity was always "backed" by his state's guaranty fund. So it was a "safer" investment than the corporate bonds you mentioned. And it was, by the facts you provided, 100 basis points higher than 10 year Treasuries and had the advantage of tax deferred earnings. My point is simply that these annuities can be good investments for conservative investors, so long as they carefully examine the details, such as surrender charges, in deciding whether they are right for them. Not all annuities are necessarily "bad," but be very careful with the salespeople (i.e., financial advisors) who sell them . . . many are more interested in their own financial benefit than their client's, like those who try to get inexperienced clients to hold an annuity inside a retirement account! There should be a special place in hell for those vampires.