The Benefits of Multi-Year Guaranteed Annuities over Taxable Bonds and Bank CDs
In a previous blog post, we talked about the downside of taxable bonds. Namely that they are tax-inefficient, subject to interest rate risk, and don’t always provide downside protection in an inflationary environment.
Multi-year guaranteed annuities (MYGAs) solve a lot of these problems by doing the following:
1) Allow investors to lock-in the majority of the higher yields of long-term bonds without the interest rate risk
2) Allow investors to defer taxes on the gains until they are in retirement (and in a lower tax bracket)
3) Provide downside protection in all environments backed by insurance company’s reserves, state guarantees, and regulation
For those that might not be familiar with MYGAs, a MYGA is a type of annuity offered by an insurance company in which the insurance company guarantees to pay the investor a set return on their investment in exchange for the investor keeping their investment with the insurance company for a set number of years. We can think of this like a certificate of deposit (CD) from a bank—except with better rates and withdrawal privileges.
The table below shows various rates and investment terms for MYGAs as of 4/17/2023:
MYGA Rates as of 4/17/2023
|Carrier||Term||AM Best Rating||Rate|
|American Life||3 years||B++||6.00%|
|Security Benefit||4 years||A-||6.00%|
|American Life||5 years||B++||6.00%|
|MassMutual Ascend||5 years||A+||5.45%|
Life Insurance Company
|In exchange for investing their money through an insurance company for a set numbers of years, investors can lock in higher rates, while deferring taxes on the gains|
Why are MYGAs better than taxable bonds?
Investing in MYGAs have numerous advantages over taxable bonds including the following:
- Investing in long-term bonds without interest rate risk: Instead of investing in short-term bonds to avoid interest rate risk, investors get access to the higher long-term interest rates without the interest rate risk since the insurance company is taking that risk.
- Ability to defer taxable gains: As we’ve touched on in previous articles, one of the problems with taxable bonds is that they are taxed at high ordinary income rates every year. While MYGAs are also taxed at high ordinary income rates, one of the key benefits here is that the taxes aren’t owed until the end of the period. So if you invest in a 5 year MYGA, you only owe taxes at the end of the 5 year period. Furthermore, if you invest in another MYGA after the 5 year period, you can defer the taxes on the gains. You can keep doing this until retirement when you are in a lower tax-bracket. By doing this you are able to defer taxes when you are in a high tax bracket until later when you are in a lower tax bracket.
- Better downside protection, credit risk, and regulation: As discussed above, investing in bonds directly subjects the investor to interest rate risk whereas that risk is borne by the insurance company. Furthermore, when an investor invests in taxable corporate bonds they are taking the full credit risk of the company issuing that bond. The company issuing that bond is not required to maintain a certain level of reserves to ensure that they have the assets to back the obligation to the investor. There is no regulation or government protection set in place to protect the investor with regards to default risk. The same is not true of investing in annuities through insurance companies. Insurance companies are heavily regulated in order to ensure that they can fulfill their obligations to the investor. Insurance companies also hold substantial surplus reserves in addition to the amount required by regulation. Furthermore, state guarantees provided the state of residence that the investor lives in, typically provide up to $250,000 in protection in the rare event that an insurance company were to not be able to follow through on its obligations. This is not provided to typical corporate bonds. In other words, investing in an insurance company with an A rating is significantly lower risk than investing in a corporate bond with that same rating due to the protections provided to insurance companies that are not provided to regular corporations issuing bonds. While corporate defaults on bond obligations are rare, they are not nearly as rare as insurance companies failing to meet their obligations because of the effect that would have on the larger financial system. As a result, governments and economies have a bias towards protecting insurance companies from failing to honor their obligations in a way that is not provided to typical corporate debt.
Why are MYGAs better than bank CDs?
While a MYGA might sound similar to a bank CD, it comes with significant tax-deferral advantages mentioned above that can’t be found in CDs. Another key advantage of MYGAs is the ability to withdraw money early without penalty. With a bank CD, the bank will charge you a penalty fee if the client wishes to withdraw money early. However, with a MYGA the investor can withdraw up to 10% of the balance each year penalty free. So for example, if the investor invests $100,000 into a MYGA, the client can withdraw $10,000 each year without penalty. So before the end of the fifth year the investor can withdraw approximately $50,000 of their initial $100,000 investment without penalty. If the client wishes to withdraw an amount above this, the penalty fee for doing so would be 10% or less of the amount withdrawn in excess of the free withdrawal.
MYGAs offer investors the ability to lock in high yields without interest rate risk and tax-deferrable benefits that can’t be found with taxable bonds. Investors who invest in target date funds or retirement funds with large bond allocations should consider utilizing MYGAs instead.