Multi-Year Guaranteed Rate Annuities vs CDs for Your Retirement Plan

Troy Sharpe: Most consumers are unaware that life insurance companies have CD-like tools that typically offer higher interest rates and also come with some additional tax advantages. We’re going to look at, what’s known as MYGAs or multi-year guaranteed rate annuities, what the benefits and downsides are to help you understand more about them.

Troy: Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, a certified financial planner professional, certified tax specialist, and also host of the Retirement Income Show. It’s always been shocking to me that people who invest heavily in CDs typically have no idea that multi-year guaranteed rate annuities exist. Now, I believe the primary reason for this is when you walk into the bank, historically speaking, talk with your banker, you have some money in cash, they’re going to direct you over to that investment desk. They’re going to try to sell you a stock or bond portfolio.

If you say, “I don’t like risk”, they’re going to get you into some of the bank CDs. This is why I believe so many CDs are purchased but when you look at the rates, if you compare CD rates and the benefits to multi-year guaranteed rate annuities, I’m just shocked that there’s not more money in these tools. Multi-year guaranteed rate annuity is similar to a CD in the sense that it is for a certain number of years, one year, two years, five years, et cetera and there is a guaranteed interest rate just like CDs for that period.

You may have three years, 2.5% or five years, 3.5%, just like a CD except it comes from a life insurance company. One of the benefits of a MYGA, multi-year guaranteed rate annuity, is that the interest that you earn, you do not have to pay tax on it that year, compared to CDs whenever you earn interest, you have to pay tax on it in that year. When we look at those two benefits, especially for non-IRA money because this is typically what gets invested in CDs, you have two main reasons why multi-year guaranteed rate annuities can be more attractive.

One, the rates, in my professional career, have always been higher than bank CDs. Then you have the tax deferral component. I want to look at analysis of these two options. We’re in the process right now of creating a search tool where you can go to our website and actually search for current rates in your state. One thing to know about the life insurance industry is that everything is state-regulated. Alaska may have different rates than Montana. Texas may have different rates than California.

If you go to Oak Harvest FG, stands for We’re creating this annuity landing page. We’re going to have a search tool here where you can type in your age, the dollar amount, the states you live in, and search what are the top multi-year guaranteed rate annuities for your area. These are the top CD rates in the country right now as of recording this video. Investopedia simply gathers all that data and they put it right here for you to see.

When we look at today’s contrasting multi-year guaranteed rate annuity environment, we see a stark difference. Before I recorded, I went online and did a national search for guaranteed rate fixed annuities, and two-years, 2.5% per year guaranteed compared to the two-year national high CD, 1.83%. Three-year, you can get 3.15% fully guaranteed right now, four-year, 3.255%, five-year, 3.6%. If we look at this five-year, 3.6% compared to the five-year CD at 2.5%, that is a pretty stark difference especially if you have a few hundred thousand dollars in CDs.

I want to also look at the tax component of it though. A five-year CD, if you have $100,000 at 2.5%, assuming you’re in about a 15% tax bracket, the end of the year, your CD is worth $102,125, the MYGA, you’re worth $103,600. Now, what I’ve done here to calculate the $102,125. This is the after-tax yield. The interest rate was 2.5%, but I assumed a 15% tax bracket, which means we actually net $102,125 because we have to write the IRS, a check for the taxes due.

At the end of year five, your CD would be worth $111,000. The MYGA would be worth $119,000. It’s a difference of $8,257. That’s a big difference. Additionally, we would’ve paid $1,875 in taxes with the CD compared to the MYGA. Now, when we’re looking at multi-year guaranteed rate annuities, that interest that you earn, it is tax-deferred and it compounds year after year after year. Whenever you take it out though, you have to pay income taxes as well. CDs are taxed at income tax rates. They do not receive capital gains or any preferential tax treatment.

There is one benefit. We’re going to explore that later on in the income planning series, it’s called the exclusion ratio. If you do decide to turn the multi-year guaranteed rate annuity at the end of the five-year period into a lifetime income or into an income over 5 years or 10 years, the exclusion ratio allows you to combine your annual payment interest and principle into one. Simply put, if we decided to turn this into an income for 5 years or 10 years, anywhere between probably 90% to 95% of your annual payment would be tax-free. Only a fifth, if it’s over five years or a tenth of the interest earned if you take income over 10 years, would be included as taxable income in your annual payment.

We’re going to dive more into that exclusion ratio, how it’s calculated, how it can be used in planning later on in this educational annuity series. We’re going to go pretty deep here. On the surface, I just wanted to compare, first and foremost, higher rates with multi-year guaranteed rate annuities and also tax deferral. One other benefit we’ve seen on some of the advanced planning, if someone comes in and let’s say they don’t need the income, they’re just on social security, they have maybe $300,000 in CDs, transferring those over to multi-year guaranteed rate annuities, getting that interest tax-deferred and earning more interest as well, oftentimes, creates less taxes on social security.

With your multi-year guaranteed rate annuities, not only do, as far as I’ve ever seen, get more interest, you also have tax deferral. You can use that exclusion ratio if you decide to what’s called annuitize that contract over a 5 or 10-year period, but one other benefit that we’ve seen simply by transferring money from CDs to the multi-year guaranteed rate annuities and getting that tax deferral on that interest, many times, we’ve seen that actually reduce the taxation of your social security income because that interest with your CD, it’s calculated into your total income, which determines how much tax you pay on your social security.

We’ve seen dozens and dozens of times over the years where we’ll make the switch from someone in CDs earning a lower interest rate to the same timeframe into multi-year guaranteed rate annuities, get that tax deferral and then social security taxation is reduced. Meaning not only are they earning more interest on that CD money with the insurance company, but they’re also keeping more of their social security check.

Multi-year guaranteed rate annuities can be a very valuable tool, especially for those that have a lot of money inside CDs, but also if you’re just looking for safety, some money to stash for a couple of years, especially in this volatile economic environment, multi-year guaranteed rate annuities can be a viable tool. If you’re working with a firm that doesn’t sell annuities or doesn’t believe in annuities, I believe you’re missing out on potentially, a very valuable piece or complement to an overall retirement plan.

Multi-Year Guaranteed Rate Annuities vs CDs for Your Retirement Plan
Multi-Year Guaranteed Rate Annuities vs CDs for Your Retirement Plan

Multi-year guaranteed rate annuities are often compared to CDs, and when looking at them as an overall strategy for your retirement plan, it's worth understanding what they are and how they can be beneficial.