What is a MYGA Annuity

What is a MYGA Annuity?

Posted On March 7, 2024 By Scott Stratton, CFP(R), CFA In Portfolio Management, Retirement Planning /  

How a fixed income annuity can provide guaranteed returns and predictable retirement income — especially for retirees in Texas, Arkansas, and nationwide.

A Multi-Year Guaranteed Annuity (MYGA) is a fixed-rate annuity that offers a guaranteed interest rate for a defined period — typically 1 to 10 years — making it a useful tool for retirees seeking predictable income or a safe place to grow cash. MYGAs are popular with conservative investors because they provide certainty in an uncertain market and can complement traditional retirement income sources.

How MYGAs Work (Straightforward Explanation)

A MYGA is an insurance contract in which you pay a lump sum upfront and the insurance company credits a fixed interest rate for a set term. Unlike market-linked investments, a MYGA offers stability — you know the rate and return ahead of time.

Here’s what this means:

  • You deposit a lump sum (often $5,000+; many competitive products start closer to $20,000+).
  • The annuity earns a guaranteed fixed rate for the term you choose (e.g., 3, 5, or 7 years).
  • Earnings grow tax-deferred until you withdraw them.
  • Upon maturity, you can take the money, renew into a new contract, or elect income payout options.

This makes MYGAs similar to CDs in principle — but with tax deferral and often higher rates.

Why Retirees Like MYGAs (Guaranteed Return and Safety)

MYGAs are especially appealing if you want:

  • Predictable, guaranteed interest income
  • Tax-deferred growth
  • A conservative portion of your retirement portfolio
  • Stability in a low-volatility product
  • Competitive Interest Rates: currently we offer a 5-year MYGA at 5.75%, a full 2% more than a 5-year Treasury Bond

Because returns are fixed, you don’t have to worry about market ups and downs affecting your principal during the contract term. For some retirees, guaranteed income products like MYGAs can complement laddered bonds and cash reserves within a well-structured retirement income planning strategy.

MYGA vs. CDs and Traditional Fixed Accounts

MYGAs are often compared to bank CDs, but there are important differences:

FeatureMYGABank CD
Rate GuaranteeGuaranteed by insurerFDIC/NCUA insured
Tax TreatmentTax-deferred earningsInterest taxed yearly
Income OptionsCan convert to incomeNo lifetime income option
LiquidityLimited, may have surrender chargesEarly withdrawal penalty
FlexibilityOptions at maturityLess flexible
Based on typical product characteristics

MYGAs are backed by insurance companies and state guaranty associations — not FDIC insurance — so the financial strength of the issuer matters.

How MYGAs Can Fit Into Retirement

MYGAs can provide predictable income or serve as a safe allocation within a broader retirement income plan. This can include:

🔹 Income Planning

If you want a fixed stream of interest income during early or established retirement, a MYGA can fill the gap between Social Security, pensions, or RMDs.

🔹 Laddering for Predictable Cash Flow

Buying MYGAs with staggered maturities ensures you can take money or reinvest at regular intervals — similar to a bond ladder.

🔹 Risk Reduction

Because returns are fixed, they provide stability in an otherwise volatile market.

For a deeper look at how MYGAs compare with other retirement tools, see our article on fixed annuities and retirement income strategy.

What You Should Know Before You Buy

MYGAs aren’t right for everyone. Key considerations include:

🔸 Liquidity and Surrender Charges

MYGAs typically have surrender periods during which withdrawals beyond a penalty-free amount may incur charges. Read the contract carefully.

🔸 Tax Considerations

Growth is tax deferred, but withdrawals are taxed as ordinary income. If you withdraw before age 59½, you may face a 10% IRS penalty on earnings.

🔸 Insurer Strength

Check the insurer’s ratings and the state guaranty association coverage limits.

These features underscore why it’s smart to work with a fiduciary who can match product features to your personal situation.

Why Consider a MYGA With Us (Texas, Arkansas & Nationwide)

If you’re a retiree seeking income — even if you’re not looking for full wealth management — MYGAs can provide competitive fixed income options with market-leading interest rates. Our access to top annuity carriers means clients in Texas, Arkansas, and across the U.S. can secure highly competitive rates and terms that align with their income goals.

We help you:

  • Evaluate options across multiple products and terms
  • Compare surrender periods, riders, and features
  • Make decisions aligned with your risk tolerance and income timeline

MYGAs can be a standalone retirement income solution or a component of a broader plan. Whether you want a safe place for excess cash or a predictable income stream, we can help you explore whether a MYGA fits your needs.

For broader retirement planning that addresses sequence of withdrawals, taxes, and longevity risk, check out our Retirement Income Strategy and our Who We Help pages.

Frequently Asked Questions

What rate can I expect on a MYGA in 2026?

Current competitive MYGA rates are about 5.75% for a 5-year and depend on term and issuer. These rates can be materially higher than traditional CDs or short-term bonds. They also vary quite a bit from insurer to insurer, so it can pay to have an independent agent who can shop around for the best rates and features.

Are MYGAs safe?

MYGAs are backed by insurance companies and state guaranty associations, not the FDIC. It’s important to review the issuer’s rating and the contract terms.

Can I use a MYGA for retirement income?

Yes. MYGAs can provide predictable income or supplement your other retirement income sources when structured appropriately.

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Guaranteed Retirement Income

Guaranteed Retirement Income

Posted On November 12, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Guaranteed Retirement Income increases satisfaction. When you receive Social Security, a Pension, or other monthly payment, you don’t have to worry about market volatility or if you will run out of money. You’re guaranteed to receive the payment for as long as you live. That is peace of mind.

Research shows that people prefer pension payments versus taking withdrawals from an investment portfolio. When you were working, you had a paycheck show up every month and you didn’t feel bad about spending it. There would be another paycheck next month. Unfortunately, with an investment portfolio, retirees dislike spending that money. There is “range anxiety” that their 401(k) or IRA will run out of money. There is fear that a market drop will ruin their plans. After spending 40 years building up an account and it’s not easy to reverse course and start to spend that nest egg and see it go down.

Corporate and Municipal pensions have been in decline for decades. As a result, most of us have only a Social Security benefit as guaranteed income. That’s too bad. 401(k) plans are a poor substitute for a good pension. You need to accumulate a million bucks just to get $40,000 a year at a 4% withdrawal rate. It places all the responsibility on American workers to fund their own retirement, and this has led to wildly disparate retirement readiness between people. Even those who accumulate significant retirement accounts still have the worries about running out of money. Sequence of Returns, poor performance or mismanagement, cognitive decline, or longevity are all risks.

The solution to create guaranteed lifetime income is a Single Premium Immediate Annuity, or SPIA. A SPIA is a contract with a life insurance company in which you trade a lump sum in exchange for a monthly payment for life. For as long as you live, you will get that monthly check, just like a Pension or Social Security. When you pass away, the payments stop. For married couples, we can establish a Survivor’s Benefit that will continue the payout (sometimes reduced at 50% or 75%) for the rest of the survivor’s life, if the owner should pass away.

How much would it cost? For a 65-year old man, a $100,000 premium would establish a $537/month payment for life. That is $6,444 a year, or a 6.4% rate on your premium. For a 65-year old woman, it would be $487, a month, or $5,844 a year (5.8%) For a couple, if the wife was also 65, that same premium would offer $425/month for both lives (100% survivors benefit). That’s $5,100 a year, or 5.1%. The greater the expected longevity, the lower the monthly payment.

There are some fairly obvious advantages and disadvantages of a SPIA.

Pros

  • Lifetime income, fixed, predictable, and guaranteed
  • No stock market risk, no performance concerns, no Sequence of Returns risk

Cons

  • Permanent decision – cannot reverse later
  • Some people will not live for very long and will get only a handful or payments back
  • No money leftover for your heirs
  • No inflation protection – monthly payout is fixed

I’ve been a financial advisor since 2004 and I have yet to have a client who wants to buy a SPIA. For some, the thought of spending a big chunk of money and the risk that they die in a year or two, is unbearable. However, the payout is fair, because some people will live for much longer than the average. The way insurance works is by The Law of Large Numbers. An insurance company is willing to take the risk that someone will live for 40 or 50 years because they know that if they sell thousands of annuities, it will work out to an average lifespan across the group. Some people live longer than average and some live less than average.

Two Ways to Use a SPIA

Although they remain unpopular, SPIAs deserve a closer look. Let’s immediately throw away the idea that you should put all your money into a SPIA. But there are two ways that a SPIA might make sense as part of your retirement income plan.

  1. Use a SPIA to cover your basic expenses. Look at your monthly budget. Assume you need $3,000 a month to cover all your expenses. If you have $2,200 in Social Security benefits, buy a SPIA that would cover the remaining $800 shortfall. For the 65-year old couple above, this $800/month joint SPIA would cost $188,235. Now you have $3,000 a month in guaranteed lifetime income to cover 100% of your basic expenses. Hopefully, you still have a large investment portfolio that can grow and supplement your income if needed.

The nice thing about this approach is that it takes a bit less cash than if you follow the 4% rule. If you needed $800 a month ($9,600 a year), a 4% withdrawal rate would require you have a portfolio of $240,000. The SPIA only requires $188,235.

Let’s say you have a $1 million portfolio. You could (a) put it all in the portfolio and start a 4% withdrawal rate, or (b) put $188,235 into the SPIA and keep the remainder in the portfolio. Here’s what that would look like for year one:

  • a. $1 million at 4% = $40,000 potential income
  • b. $188,235 SPIA = $9,600, PLUS $811,765 portfolio at 4% = $32,470. The combined income from the SPIA and portfolio is now $42,070

You have increased your income by $2,070 a year and you have established enough guaranteed income to cover 100% of your monthly needs. Then, you are not dependent on the market to cover your basic expenses each month.

2. The second way to think of a SPIA is as a Bond replacement for your portfolio. Instead of buying Treasury Bonds and worrying if you will outlive them, you can buy a SPIA, and the insurance company will buy very safe bonds. The insurance company then assumes your Longevity risk.

Back to our example above, let’s say your $1 million portfolio is invested in a 60/40 allocation (60% stocks, 40% bonds). Just consider the SPIA as part of your fixed income sleeve. If you had a target of $400,000 in bonds, rather than letting them sit in 10-year Treasuries earning 0.7% today, go ahead and put $188,235 in the SPIA and keep $211,765 in bonds. Your $600,000 in stocks remains the same. Now, on your SPIA, you are getting a withdrawal rate of 5.1% to 6.4%. And although you are eating your principal with a SPIA, you have no longevity risk, it’s a guaranteed check. You have reduced the withdrawal requirement from your equities and can better weather the ups and downs of the stock market.

Is a SPIA Right For You?

A SPIA isn’t going to be for everyone. But if you want lifetime guaranteed retirement income a SPIA is a solid, conservative choice. Used in conjunction with the other pieces of your income plan (Social Security and Investment portfolio), a SPIA can help you sleep well at night. Especially for investors who are in great health and with a family history of longevity, it may be worth putting some money into a SPIA and turning on that monthly check. It can help offset the stock market risks that could derail your plans.

I know many parents think putting money into a SPIA will reduce money for their kids to inherit. That might be true. Of course, if you live a long time and run out of money, you won’t be leaving any money to your kids either. Our goal with any retirement income solution is to make sure you don’t outlive your money, which hopefully also means you are able to leave some money to your heirs.

What if the insurance company goes under? Isn’t that a risk? It is. Thankfully, most states protect SPIA policy holders up to $250,000. If you are planning to put more than $250,000 into a SPIA, I would seriously consider dividing your funds between several companies to stay under the limits. Read more: The Texas Guaranty Association. (Note that this information is provided solely for educational purposes and is not an inducement to a sale.)

In the next three articles in this five-part series, we will look at different withdrawal strategies for your investment portfolio. These approaches include the 4% rule, a Guardrails approach, and 5-year Buckets. All of these will help you manage the risks of funding retirement from stocks. But before we get to those, I wanted you to realize that you don’t have to put all your money into stocks to create retirement income. These withdrawal approaches are likely to work, and we know they worked in history. But if you want to buy your own pension and have a guaranteed retirement income, a SPIA could be the right tool for the job.

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How to Increase Your Yield

How to Increase Your Yield

Posted On August 2, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Opportunities for a Low Yield World, Part 2

Last week, we discussed how not to increase your yield today: by replacing safe bonds with high yield bonds. That’s because the potential for rising defaults today in junk bonds could have a major drag on what would otherwise appear to be a healthy yield. While the typical default rate for single-B and double-B bonds is 2-4% a year, in a crisis it could go much higher. In 2009, for example, global high yield bonds saw a 13% default rate that year.

It’s important to understand the risks in your bond portfolio and know what you own. There are four opportunities today for investors to improve their yields today, without simply trading down to junk bonds. None of these are home runs, but offer a bit more yield. And in the current low interest rate environment, increasing your yield by even one percent could be doubling your rate of return from your bonds. Some investors will choose to skip bonds altogether and add to their equities, but that would take on a lot of additional risk. For investors who want the risk and return profile of say a 60/40 portfolio, there’s no substitute for the safety of bonds.

1. Cash: Online Savings Account, not a Money Market Fund

Today, the Federal Reserve has lowered rates to basically zero. There is almost no yield on T-Bills, bank accounts, and short-term CDs. I see a lot of investors who park significant cash in a money market fund or in a Bank savings account. Those rates may have been near two percent a year ago, but many are now at 0.01%. That’s a whole one dollar of interest for a $10,000 investment each year! Not only are you not growing your cash, you probably aren’t going to keep up with inflation either. Your purchasing power is likely to decline with each passing year.

Instead of a money market at 0.01%, park your cash in an online savings account. You can link it to your primary checking account, and transfer money as needed. Most are FDIC insured, and several have no account minimums and no monthly fees. The one I use: Marcus.com from Goldman Sachs Bank. The current rate is 1.05%, with no minimums and no fees. You can open an account in about 1 minute and there’s an app for iOS and Android. I cannot think of any reason to not do this if you are presently earning 0.01% on a money market.

2. Buy Insured Municipal Bonds, not Taxable Corporates

The Coronavirus didn’t just hurt companies. Municipal Bonds – which are issued by cities, states, schools, and local entities – depend on taxes or revenues. Revenues from Stadiums, Toll Roads, etc., are down and so are taxes from sales, restaurants and bars, gasoline, income, and everything else which is taxed. The municipal bond market really doesn’t know how to evaluate this unprecedented problem. Compounding this issue is the fact that there are hundreds of thousands of different bonds, issued by 50,000 different entities. Some of these bonds are so small that they rarely trade.

The result is that we can now buy a tax-free, A-rated municipal bond with a higher yield than we can buy an A-rated corporate bond which is taxable. This doesn’t help retirement accounts, like a 401(k) or IRA, but if you are buying bonds in a taxable account, taxes matter. Imagine two bonds both yield 2%. One is tax-free and the other one is going to cost you 22 to 37 percent in income taxes. That’s a big difference when we consider after-tax returns!

It is unusual to find yields on tax-free municipal bonds being higher than on corporate bonds of a similar credit quality and duration. For folks in a high tax bracket, taking profits on your corporate bonds and shifting to munis can make sense. (Profits on your appreciated, high-priced corporate bonds can qualify for long-term capital gains rate of 15%, a lower tax rate than receiving the bond’s income and waiting for them to mature at par.)

If you are concerned about the credit quality of municipal bonds, look for bonds which are insured. Bond insurers offer protection to muni bond holders to cover losses of income and principal, should a municipality default. At this point, defaults on municipal bonds remain much lower than from corporate bonds. The highest rated insurer is AGMC, and those bonds remain AA- rated.

We build portfolios of individual municipal bonds for clients with taxable accounts over $250,000. For investors with smaller portfolios, you can achieve a similar benefit with an intermediate municipal bond fund.

3. Buy 5-year Fixed Annuities, not 5-year Bonds

Where are the yields of 5-year fixed income products this week? The 5-year Treasury bond has a yield of 0.27%. The best rate I have on a 5-year CD is 0.55%. I see an A- rated 5-year corporate bond from JP Morgan at 0.95%. Munis are better, but still only 1.0 to 1.3% tax-free for an A-rated bond.

The best place to park money for five years remains a fixed annuity. Today I see several annuities in the 3.0 and 3.1 percent range for a five year product. That’s basically triple the yield of corporates and about 6-times the yield from CDs. A fixed annuity is guaranteed, both for the rate of return and your principal. There is a trade-off with annuities. They charge very steep surrender charges if you need to access your money early. However, if you aren’t going to tap the account for 5+ years, it can make sense to put some money into an annuity.

Whenever people ask me how they can earn more while keeping their money safe, I discuss the pros and cons of an annuity. For today’s bond investors, a Multi-Year Guaranteed Annuity (MYGA) can be a way to increase your yield while keeping high credit quality.

4. Buy Preferred Stocks, Not a High Yield Fund

The High Yield ETF (HYG) currently has an SEC yield of 5.06%. There are a couple of reasons I prefer to own preferred stocks, besides the default risks I shared last week. First, I can save the ETF expense ratio of 0.49%. This is actually low compared to most high yield funds. When you own Preferreds directly, you might be saving one-half to one percent versus paying the expense ratio of a fund. At a 5% yield today, that is a 10-20% improvement. Yields are very low today, but expense ratios have not come down. Now, expenses eat up a larger portion of your return, leaving you with less income.

Second, preferreds today are offering a yield of 5-7%, which is attractive compared to bonds from the same company. For example, AT&T has preferred which yields 4.8% and is callable in 5 years. The February 2030 AT&T regular bond, however, yields less than 2.25% today. First Horizon Bank sold a 6.5% preferred this year, callable in five years. Their five year bonds, today, are available for a purchase with only a 1.865% yield.

Generally, the bonds are “safer” than preferreds, as they would rate higher in a bankruptcy liquidation. That’s one reason for the different yields, as well as the longer duration of the preferreds. Still, if you are comfortable with the credit risk of a company, the Preferreds may be trading at a significantly higher yield than the bonds of the company. That’s an opportunity today.

Why do we write so much about fixed income? For many of our investors who have achieved their accumulation goals, moving from growth into preservation and income is important. And there is an opportunity for us to add value through our fixed income choices: to increase yield, improve credit quality, or to reduce your risks. While it is relatively easy and fast to trade equity ETFs, buying individual bonds can require hours of research and trading.

Stocks have gotten all our attention this year, but don’t ignore your fixed income. The great return of fixed income in recent years has largely been the result of falling yields increasing the value/price of your bonds. Today, at nearly zero, yields could prove disappointing going forward. Our goal is to help you get more yield without simply taking on a lot of credit or duration risk.

Of these four ideas, you can certainly do #1 on your own. For #2 through #4, though, I think you will want to work with a financial professional. If you’d like to learn about individual municipal bonds, fixed annuities, or Preferred Stocks, please give me a call.

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Safe Investing During Deflation

Safe Investing During Deflation

Posted On May 17, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

How do you begin to think about safe investing during deflation? Last week, the US Bureau of Labor Statistics reported that the CPI-U fell 0.8% in April. The Consumer Price Index is a basic measure of inflation and has almost always been positive throughout US History. Deflation is not a good environment for building wealth.

While this could be a temporary blip due to falling energy prices in April, we certainly are not out of the woods from the economic damage of the Coronavirus. With 20.5 million people filing for Unemployment in the last two months, there could be an extended reduction in consumer demand. And we know from Econ 101 that when demand shifts down, there becomes an oversupply of goods, and prices fall. That’s deflation.

I think that any deflation will be temporary and that the global economy will recover. But the amount of time this takes could be anywhere from months to years. And while I am studying projections of the depth and duration of this likely recession, my readers know what I think about expert predictions. They are wildly inaccurate. Trying to time the market based on economic predictions is likely to do worse than staying the course.

Deflation Is Anti-Growth

What might deflation mean for investors? Historically, stocks do poorly during deflationary periods. Commodities and Real Assets also can lose value. If millions of people lose their jobs and income, how are they going to afford a mortgage and buy a house? We know from 2008 that house prices can go down when people cannot buy houses.

No one has a crystal ball to know what will happen next. But, I think investors can and will want to make small adjustments to their investment portfolios because of the possibility of deflation. With the market rebounding incredibly well from the March lows, the upside versus downside potential in the near term has worsened.

It is okay to want to have some of your investments in a safe asset. The challenge that we discussed in the previous blog is that we are near zero percent interest rates today on cash, CDs, and Treasury Bills. While this would technically preserve purchasing power in a deflationary environment, we can do better and should be looking to grow.

Fixed Annuities For Capital Preservation

My suggestion for a safe yield today: fixed annuities. This week, I had a client purchase a 5-year annuity at 2.9%. That is 2.6% higher than a 5-year Treasury bond today (0.307%). Both are guaranteed, yet the annuity gets a bad rap. Sometimes, an annuity is the right tool for the job. Sometimes, it is not. Unfortunately, because some unscrupulous salespeople sold annuities which were unsuitable for the buyers, investors have negative perceptions.

I keep bringing them up because they are an objectively effective fixed income solution that many savers would appreciate. Because I want every investor to make informed decisions, here is what you need to know about Fixed Annuities.

Annuity Basics

  1. An annuity is issued by an insurance company and is a contract between the company and you. There are many flavors of annuities, but the kind I am discussing today are Fixed Annuities, specifically Multi-Year Guaranteed Annuities (MYGAs).
  2. A MYGA has a set term (3, 5, 7, or 10 years commonly) and a fixed rate of return. In this aspect, it behaves similarly to a CD.
  3. An Annuity is a tax-deferred retirement vehicle. You will not pay any taxes on the gains from the annuity, until you withdraw the money. At the end of the term, you can roll into a new annuity and continue to defer the gains. This is called a 1035 Exchange. There are no income restrictions or contribution limits to annuities.
  4. If you withdraw from an Annuity before age 59 1/2, there is a 10% penalty on the gains. Annuities are most popular with investors over 55, but younger people who know they are not going to need the money until retirement can also use a MYGA towards retirement saving. You can invest IRA money (Traditional, Roth, etc.) into an Annuity, too.
  5. There are often large penalties if you withdraw money from an annuity before its term is complete. For this reason, it is very important to have other sources of liquid assets. That way you can remain in the annuity for the full term.
  6. What happens if an Insurance Company fails? Annuities are insured at the State level by a mandatory Guaranty Association. In Texas, all insurers pay premiums to the Texas Guaranty Association, which protects annuity holders up to $250,000. This information is for educational purposes only and is not an inducement to buy insurance. If you have more than $250,000 to invest, spread your money over several insurance companies to stay under the covered limit.

How to Use MYGAs

A MYGA is a good substitute for a bond or bond fund. They offer safety and capital preservation, but with a higher rate of return than cash, CDs, or T-Bills available today. While there are some corporate and municipal bonds with higher yields, they are generally not guaranteed and carry risk that the issuer could default and be unable to pay. That’s especially a problem during deflation, as bankruptcies could increase significantly, causing losses to bondholders.

The main trade-off with MYGAs is the lack of liquidity. We want to keep annuity purchases to a reasonable size. I also recommend creating a 5-year ladder, where you divide your total investment into 5 pieces which will mature in 1,2,3,4, and 5 years. Then in each subsequent year, you will have access to 20% of your investment, should you need it. And what you don’t need, you can reinvest into a new 5-year annuity at the top of the ladder.

Lastly, for transparency, Annuities pay a commission. If someone purchases a MYGA from me, the insurance company will pay me a commission on the sale. I generally view commissions as a conflict of interests. However, I’d point out that a 2.9% yield on a MYGA is the net return to the investor.

There are no investment advisory fees for Annuities. For some reason, I don’t hear very many Investment Advisors mentioning that to their clients when they bash Annuities! I want what is going to be best for you. If that’s an annuity, fine, and if not, that’s fine too. echo The minimum investment on most annuities is $10,000, but if you have a smaller amount, let me know.

Stay Diversified, Increase Safer Positions

Safe investing during deflation can be a challenge. Low interest rates aren’t helping investors. I will continue to recommend diversified portfolios which may have 50% or more in stocks for long-term investors. Still, there is a role for safe investments for most portfolios, and many people may want to have more safe investments. They offer ballast against the risk of stocks and the diversification can give a smoother trajectory to your overall return.

Given the strong rebound we have had from the March 2020 crash, this may not be a bad time to reevaluate your risk profile. If that thought process has you wondering about safe investing during deflation, lets talk about MYGAs. I am an independent agent and can offer annuities from many different companies to find you the best features and rate for your needs.

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Retirement Income at Zero Percent

Retirement Income at Zero Percent

Posted On May 3, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

With interest rates crushed around the world, how do you create retirement income at zero percent? Fifteen years ago, conservative investors could buy a portfolio of A-rated municipal bonds with 5 percent yields. Invest a million dollars and they used to get $50,000 a year in tax-free income.

Not so today! Treasury bonds set the risk-free rate which influences all other interest rates. Currently, the rate on a 10-year Treasury is at 0.618 percent. One million dollars in 10-year Treasuries will generate only $6,180 in interest a year. You can’t live off that.

You can do a little better with municipal bonds today, maybe 2-3 percent. Unfortunately, the credit quality of municipal bonds is much worse today than it was 15 years ago. A lot of bonds are tied to revenue from toll roads, arenas, or other facilities and are seeing their revenue fall to zero this quarter due to the Coronavirus. How are they going to repay their lenders?

Debt levels have risen in many states and municipalities. Pension obligations are a huge problem. The budget issues in Detroit, Puerto Rico, Illinois, and elsewhere are well known. Shockingly, Senator McConnell last week suggested that states maybe should be allowed to go bankrupt. That would break the promise to Municipal Bond holders to repay their debts. This is an appalling option because it would cause all states to have to pay much higher interest rates to offset the possibility of default. And unlike Treasury bonds which are owned by institutions and foreign governments, Municipal Bonds are primarily owned by American families.

With Treasuries yielding so little and Municipal Bonds’ elevated risks, how do you plan for retirement income today? We can help you create a customized retirement income plan. Here are three parts of our philosophy.

1. Don’t Invest For Income

We invest for Total Return. In Modern Portfolio Theory, we want a broadly diversified portfolio which has an efficient risk-return profile, the least amount of risk for the best level of return. We focus on taking withdrawals from a diversified portfolio, even if it means selling shares.

Why not seek out high dividend yields and then you don’t have to touch your principal? Wouldn’t this be safer? No, research suggests that a heavy focus on high yields can create additional risks and reduce long-term returns. Think of it this way: Company A pays a 5% yield and the stock grows at zero percent; Company B pays no yield but grows at 8%. Clearly you’d be better off with the higher growth rate.

When you try to create a portfolio of high yield stocks, you end up with a less diversified portfolio. The portfolio may be heavily concentrated in just a few sectors. Those sectors are often low growth (think telecom or utilities), or in distressed areas such as oil stocks today. The distressed names have both a higher possibility of dividend cuts, as well as significant business challenges and high debt.

The poster child for not paying dividends is Warren Buffett and his company, Berkshire Hathaway. He’s never paid a dividend to shareholders in over fifty years. Instead, he invests cash flow into new acquisitions of well-run businesses or he buys stocks of other companies. Over the years, the share price of BRK.A has soared to $273,975 a share today. If investors need money, they can sell their shares. This is more tax-efficient, because dividend income is double taxed. The corporation has to pay income taxes on the earnings and then the investor has to pay taxes again on the dividend. When a company grows, the investor only pays long-term capital gains when they decide to sell. And the company can write off the money it reinvests into its businesses.

2. Create a Cash Buffer

Where a total return approach can get you into trouble is when you have to sell stocks in a down market. If you need $2,000 a month and the price of your mutual fund is $10/share, you sell 200 shares. But in a Bear Market when it’s down 20%, you’d have to sell 250 shares (at $8/share) to produce the same $2,000 distribution. When you sell more shares, you have fewer shares left to participate in any subsequent recovery.

This is most problematic in the early years of retirement, a fact which is called the Sequence of Returns Risk. If you have a Bear Market in the first couple of years of retirement, it is more likely to be devastating than if you have the same Bear Market in your 20th year of retirement.

To help avoid the need to sell into a temporary drop, I suggest keeping 6-12 months in cash or short-term bonds so you do not have to sell shares. Additionally, I prefer to set dividends to pay out in cash. If we are receiving 2% stock dividends and 2% bond interest, and need 4% a year, we would have to sell just two percent of holdings. This just gives us more flexibility to not sell.

Also, I like to buy individual bonds and ladder the maturities to meet cash flow needs. If your RMD is $10,000 a year, owning bonds that mature at $10,000 for each of the next five years means that we will not have to touch stocks for at least five years. This approach of selling bonds first is known as a Rising Equity Glidepath and appears to be a promising addition to the 4% Rule.

3. Guaranteed Income

The best retirement income is guaranteed income, a payment for life. This could be Social Security, a government or company Pension, or an Annuity. The more you have guaranteed income, the less you will need in withdrawals from your investment portfolio. We have to be fairly conservative in withdrawal rates from a portfolio, because we don’t know future returns or longevity. With guaranteed income, you don’t have to fear either.

We know that Guaranteed Income improves Retirement Satisfaction, yet most investors prefer to retain control of their assets. But if having control of your assets and the ability to leave an inheritance means lower lifetime income and higher risk of failure, is it really worth it?

I think that investors make a mistake by thinking of this as a binary decision of 100% for or against guaranteed income. The more sophisticated approach is to examine the intersection of all your retirement income options, including when to start Social Security, comparing lump sum versus pension options, and even annuitizing a portion of your nest egg.

Consider, for example, if you need an additional $1,000 a month above your Social Security. For a 66-year old male, we could purchase a Single Premium Immediate Annuity for $176,678 that would pay you $1,000 a month for life. If you instead wanted to set up an investment portfolio and take 4% withdrawals to equal $1,000 a month, you would need to start with $300,000. So what if instead of investing the $300,000, you took $176,678 and put that into the annuity? Now you have guaranteed yourself the $1,000 a month in income you need, and you still have $123,322 that you could invest for growth. And maybe you can even invest that money aggressively, because you have the guaranteed annuity income.

Conclusion

It’s a challenge to create retirement income at zero percent interest rates. Unless you have an incredibly vast amount of money, you aren’t going to get enough income from AAA bonds or CDs today to replace your income. We want to focus on a total return approach and not think that high dividend stocks or high yield bonds are an easy fix. High Yield introduces additional risks and could make long-term returns worse than a diversified portfolio.

Instead, we want to create a cash buffer to avoid selling in months like March 2020. We own bonds with maturities over five years to cover our distribution or RMD needs. Beyond portfolio management, a holistic approach to retirement income evaluates all your potential sources of income. Guaranteed income through Social Security, Pensions, or Annuities, can both reduce market risk and reduce your stress and fear of running out of money. The key is that these decisions should be made rationally with an open mind, based on a well-educated understanding and actual testing and analysis of outcomes.

These are challenging times. If you are recently retired, or have plans to retire in the next five years, you need a retirement income plan. We had quite a drop in March, but recovered substantially in April. The economy is not out of the woods from Coronavirus. I think global interest rates are likely to remain low for years. If you are not well positioned for retirement income, make changes soon, using the strength in today’s market to reposition.

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Long Bonds Beating Stocks in 2019

Posted On September 2, 2019 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Through August 31, the S&P 500 Index is up 18.34%, including dividends. Would it surprise you to learn that bonds did even better? The Morningstar US Long Government Bond Index was up 18.40% in the same period. Even with this remarkable stock market performance, you would have done slightly better by buying a 30-year Treasury Bond in January!

How do bonds yielding under 3% give an 18% gain in eight months? Bond prices move inversely to yields, so as yields fall, prices rise. The longer the duration of the bond, the greater impact a change of interest rates has on its price. This year’s unexpected decrease in rates has sent the prices of long bonds soaring. While bonds have made a nice contribution to portfolios this year because of their price increases, today’s yields are not very attractive. And longer dated bonds – those which enjoyed the biggest price increases in 2019 – could eventually suffer equivalent losses if interest rates were to swing the other direction. We find bonds going up 18% to be scary and not something to try to chase. 

Today’s low interest rates are a conundrum for investors. The yields on Treasury bonds, from the shortest T-Bills to 10-year bonds are all below 2%. CDs, Municipal bonds, and investment grade corporate bonds have all seen their yields plummet this year. In some countries, there are bonds with zero or even negative yields.

What can investors do? I am going to give you three considerations before you make any changes and then three ideas for investors who want to aim for higher returns.

1. Don’t bet on interest rates. Don’t try to guess which direction interest rates are going to go next. We prefer short (0-2 year) and intermediate (3-7 year) bonds to minimize the impact that interest rates will have on the price of bonds. With a flat or inverted yield curve today, you are not getting paid any additional yield to take on this interest rate risk. Instead, we take a laddered approach. If you own long bonds which have shot up this year, consider taking some of your profits off the table.

2. Bonds are for safety. The reason why we have a 60/40 portfolio is because a portfolio of 100% stocks would be too risky and volatile for many investors. Bonds provide a way to offset the risk of stocks and provide a smoother trajectory for the portfolio. If this is why you own bonds, then a decrease in yield from 3% to 2% isn’t important. The bonds are there to protect that portion of your money from the next time stocks go down 20 or 30 percent.

3. Real Yields. Many of my clients remember CDs yielding 10 percent or more. But if inflation is running 8%, your purchasing power is actually only growing at 2%. Similarly, if inflation is zero and you are getting a 2% yield, you have the same 2% real rate of return. While yields today are low on any measure, when we consider the impact of inflation, historical yields are a lot less volatile than they may appear. 

Still want to aim for higher returns? We can help. Here are three ideas, depending on how aggressive you want to go.

1. Fixed Annuities. We have 5-year fixed annuities with yields over 3.5%. These are guaranteed for principal and interest. We suggest building a 5-year ladder. These will give you a higher return than Treasuries or CDs, although with a trade-off of limited or no liquidity. If you don’t need 100% of your bonds to be liquid, these can make a lot of sense. Some investors think annuity is a dirty word, and it’s not a magic bullet. But more investors should be using this tool; it is a very effective way to invest in fixed income today. 
Read more: 5-year Annuity Ladder

2. High Yield is getting attractive. Back in 2017, we sold our position in high yield bonds as rising prices created very narrow spreads over investment grade bonds.  Those spreads have widened this year and yields are over 5%. That’s not high by historical standards, but is attractive for today. Don’t trade all your high quality bonds for junk, but adding a small percentage of a diversified high-yield fund to a portfolio can increase yields with a relatively small increase in portfolio volatility.

3. Dividend stocks on sale. While the overall stock market is only down a couple of percent from its all time high in July, I am seeing some US and international blue chip stocks which are down 20 percent or more from their 2018 highs. Some of these companies are selling for a genuinely low price, when we consider profitability, book value, and future earnings potential. And many yield 3-5%, which is double the 1.5% you get on the US 10-year Treasury bond, as of Friday. 

While we don’t have a crystal ball on what the stock market will do next, if I had to choose between owning a 10-year bond to maturity or a basket of companies with a long record of paying dividends, I’d pick the stocks. For investors who want a higher yield and can accept the additional volatility, they may want to shift some money from bonds into quality, dividend stocks. For example, a 60/40 portfolio could be moved to a 70/30 target, using 10% of the bonds to buy value stocks today. 

When central banks cut rates, they want to make bonds unattractive so that investors will buy riskier assets and support those prices. When rates are really low, and being cut, don’t fight the Fed.

Long bonds have had a great performance in 2019 and I know the market is looking for an additional rate cut. But don’t buy long bonds looking for capital appreciation. Trying to bet on the direction of interest rates is an attempt at market timing and investors ability to profit from timing bonds is no better than stocks. If you are concerned how today’s low yields are going to negatively impact your portfolio going forward, then let’s talk through your options and see which might make the most sense for your goals.  

Source of data: Morningstar.com on September 2, 2019.

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How to Create Your Own Pension

Posted On May 5, 2018 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

With 401(k)s replacing pension plans at most employers, the risk of outliving your money has been shifted from the pension plan to the individual. We’ve been fortunate to see many advances in heath care in our lifetime so it is becoming quite common for a couple who retire in their sixties to spend thirty years in retirement. Today, longevity risk is a real concern for retirees.

With an investment-oriented retirement plan, we typically recommend a 4% withdrawal rate. We can then run a Monte Carlo simulation to estimate the possibility that you will deplete your portfolio and run out of money. And while that possibility is generally small, even a 20% chance of failure seems like an unacceptable gamble. Certainly if one out of five of my clients run out of money, I would not consider that a successful outcome.

Social Security has become more important than ever because many Baby Boomers don’t have a Pension. While Social Security does provide income for life, it is usually not enough to fund the lifestyle most people would like in retirement.

What can you do if you are worried about outliving your money? Consider a Single Premium Immediate Annuity, or SPIA. A SPIA is an insurance contract that will provide you with a monthly payment for life, in exchange for an upfront payment (the “single premium”). These are different from “deferred” annuities which are used for accumulation. Deferred annuities come in many flavors, including, fixed, indexed, and variable.

Deferred annuities have gotten a bad rap, in part due to inappropriate and unethical sales practices by some insurance professionals. For SPIAs, however, there is an increasing body of academic work that finds significant benefits.

Here’s a quote on a SPIA from one insurer:
For a 65-year old male, in exchange for $100,000, you would receive $529 a month for life. That’s $6,348 a year, or a 6.348% annual payout. (You can invest any amount in a SPIA, at the same payout rate.)

You can probably already guess the biggest reason people haven’t embraced SPIAs: if you purchase a SPIA and die after two months, you would have only gotten back $1,000 from your $100,000 investment. The rest, in a “Life only” contract is gone.

But that’s how insurance works; it’s a pooling of risks, based on the Law of Large Numbers. The insurance company will issue 1,000 contracts to 65 year olds and some will pass away soon and some will live to be 100. They can guarantee you a payment for life, because the large number of contracts gives them an average life span over the whole group. You transfer your longevity risk to the insurance company, and when they pool that risk with 999 other people, it is smoothed out and more predictable.

There are some other payment options, other than “Life Only”. For married couples, a Joint Life policy may be more appropriate. For someone wanting to leave money to their children, you could select a guaranteed period such as 10 years. Then, if you passed away after 3 years, your heirs would continue to receive payouts for another 7 years.

Obviously, these additional features would decrease the monthly payout compared to a Life Only policy. For example, in a 100% Joint Policy, the payout would drop to $417 a month, but that amount would be guaranteed as long as either the husband or wife were alive.

There are some situations where a SPIA could make sense. If you have an expectation of a long life span, longevity risk might be a big concern. I have clients whose parents lived well into their nineties and who have other relatives who passed 100 years old. For those in excellent health, longevity is a valid concern.

There are a number of different life expectancy calculators online which will try to estimate your longevity based on a variety of factors, including weight, stress, medical history, and family history. The life expectancy calculator at Time estimates a 75% chance I live to age 91.

Who is a good candidate for a SPIA?

  • Concerned with longevity risk and has both family history and personal factors suggesting a long life span,
  • Need income and want a payment guaranteed for life,
  • Not focused on leaving these assets to their heirs,
  • Have sufficient liquid funds elsewhere to not need this principal.

What are the negatives of the SPIA? While we’ve already discussed the possibility of receiving only a few payments, there are other considerations:

  • Inflation. Unlike Social Security, or our 4% withdrawal strategy, there are no cost of living increases in a SPIA. If your payout is $1,000 a month, it stays at that amount forever. With 3% inflation, that $1,000 will only have $500 in purchasing power after 24 years.
  • Low Interest Rates. SPIAs are invested by the insurance company in conservative funds, frequently in Treasury Bonds. They match a 30-year liability with a 30-year bond. Today’s SPIA rates are very low. I can’t help but think that the rates will be higher in a year or two as the Fed raises interest rates. Buying a SPIA now is like locking in today’s 30-year Treasury yield.
  • Loss of control of those assets. You can’t change your mind once after you have purchased a SPIA. (There may be an initial 30-day free look period to return a SPIA.)

While there are definitely some negatives, I think there should be greater use of SPIAs by retirees. They bring back many of the positive qualities that previous generations enjoyed with their corporate pension plans. When you ask people if they wish they had a pension that was guaranteed for life, they say yes. But if you ask them if they want an annuity, they say no. We need to do a better job explaining what a SPIA is.

The key is to think of it as a tool for part of the portfolio rather than an all-encompassing solution to your retirement needs. Consider, for example, using a SPIA plus Social Security to cover your non-discretionary expenses. Then you can use your remaining investments for discretionary expenses where you have more flexibility with those withdrawals. At the same time, your basic expenses have been met by guaranteed sources which you cannot outlive.

Since SPIAs are bond-like, you could consider a SPIA as part of your bond allocation in a 60/40 or 50/50 portfolio. A SPIA returns both interest and principal in each payment, so you would be spending down your bonds. This approach, called the “rising equity glidepath“, has been gaining increased acceptance by the financial planning community, as it appears to increase the success rate versus annual rebalancing.

There’s a lot more we could write about SPIAs, including how taxes work and about state Guaranty Associations coverage of them. Our goal of finding the optimal solution for each client’s retirement needs begins with an objective analysis of all the possible tools available to us.

If you’re wondering if a SPIA would help you meet your retirement goals, let’s talk. I don’t look at a question like this assuming I already know the answer. Rather, I’m here to educate you on all your options, so we can evaluate the pros and cons together and help you make the right decision for your situation.

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Can You Reduce Required Minimum Distributions? (Updated for 2026)

Posted On June 25, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies /   1 Comment

Required Minimum Distributions (RMDs) are withdrawals the IRS mandates from most traditional retirement accounts once you reach a certain age — and those ages are changing under current law. This article explains when RMDs begin in 2026, how they are calculated, and practical ways to reduce the tax impact of RMDs as part of a broader retirement income plan.

What Are RMDs and When Do They Begin in 2026?

An RMD is the minimum amount the IRS requires you to withdraw from eligible retirement accounts each year once you reach a specified age. These withdrawals are generally taxable as ordinary income.

Under current law:

  • Age 73: You must begin RMDs if you are born between 1951 and 1959.

  • Age 75: You will begin RMDs if you are born in 1960 or later, with this rule in effect starting in 2033.

The first RMD is due by April 1 of the year after you reach the applicable age. After that, all RMDs must be taken by December 31 each year. However, I recommend you do not delay your first RMD until the following year as it will require to take two (taxable) distributions in the same tax year.

Important Notes

  • RMDs apply to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and other defined contribution plans.

  • You can withdraw more than the minimum in any year.

  • Roth IRAs do not require RMDs during the account owner’s lifetime, though beneficiaries must take distributions after the owner’s death.

Required Minimum Distributions often force income at inconvenient times, which is why they should be addressed within a comprehensive retirement income planning strategy rather than reactively each year.

Can You Avoid RMDs?

No — once you reach the age where RMDs begin, you generally must take them. However, there are a handful of legitimate strategies to reduce their impact on your taxes and retirement planning. Reducing future RMDs often requires coordinated Roth conversion planning.

Reducing RMDs is rarely about a single tactic. It requires coordinated decisions around Roth conversions, charitable giving, and income timing as part of an overall tax planning for retirees approach.

Strategy 1: Use Qualified Charitable Distributions (QCDs)

Qualified Charitable Distributions (QCDs) allow you to give up to $105,000 per year directly from your IRA to a qualified charity, and the donated amount counts toward your RMD without adding to taxable income.

This means:

  • Your RMD requirement is satisfied

  • Your taxable income is lower

  • You remain in potentially lower tax brackets

QCDs are especially useful for retirees who are charitably inclined and want to lower adjusted gross income (AGI) for Medicare, taxation of Social Security benefits, or subsidy eligibility such as ACA planning. (See also: Using the ACA to Retire Early) You do not have to itemize your tax return to benefit from a QCD.

Strategy 2: Roth Conversions Before RMD Age

A Roth conversion means paying tax now to move money from a traditional IRA to a Roth IRA — and Roth IRAs do not have RMDs during your lifetime.

Benefits:

  • Decreases future RMD amounts

  • Reduces future taxable income

  • Provides tax-free income later

Roth conversions work best in years when your taxable income is lower than usual or before RMDs begin. This strategy is one core reason many retirees coordinate Roth conversions with Social Security timing and other planning moves. (See: Roth Conversions After 60) Converting assets during a Bear Market, when their value may be temporarily lower, is a very effective strategy.

Strategy 3: Qualified Longevity Annuity Contracts (QLACs)

A QLAC is a deferred annuity that allows you to remove a portion of your traditional IRA from RMD calculations while deferring income until a later age (as late as 85).

Key points:

  • The amount invested in a QLAC is excluded from your IRA balance when calculating RMDs.

  • Payouts begin at a future date you choose.

  • QLACs can be effective for mitigating large RMDs during certain years.

Strategy 4: Still Working Exception With Employer Plans

If you are over the RMD age but still working, and not a 5% owner of the business, you might be able to delay RMDs from your current employer’s retirement plan (e.g., 401(k)), though this exception does not apply to IRAs.

This can provide additional flexibility in managing your income and taxable distributions. Ask your 401(k) if they can allow you to roll your IRA into your 401(k).

Strategy 5: Asset Location

Placing bonds in your IRA will also benefit because it will keep your IRA from having high growth.  Otherwise, if your IRA grows by 20%, your RMDs will grow by 20%.

It is more tax efficient to keep growth stocks and ETFs in a taxable account and your bonds in an IRA. This allows you to receive favorable long-term capital gains treatment (0%, 15%, or 20%) for stocks, a tax benefit which is lost in an IRA.  Lastly, if you hold the stocks for life, your heirs may receive a step-up in basis, which they will not in an IRA.

How RMDs Are Calculated

The IRS calculates RMDs using your retirement account balance at the end of the prior year divided by a life expectancy factor from the IRS tables. IRS

If you have multiple traditional IRA accounts, the IRS lets you aggregate your RMDs — calculate each separately, then take the total from any one or combination of traditional IRAs. However, RMDs from 401(k)s generally cannot be aggregated with IRAs.

What Happens if You Miss an RMD

If you fail to take your RMD or do not take enough, the IRS may impose a penalty. Previous penalties were 50% of the amount not withdrawn, but under later interpretation and relief provisions, a 25% excise tax may apply, reduced to 10% if corrected within two years using Form 5329. IRS

Recent IRS reminders underline the importance of meeting deadlines and taking RMDs accurately to avoid costly penalties.

How RMD Planning Fits Into Retirement Income Strategy

RMDs are just one piece of a larger retirement income plan. Thoughtful planning should consider:

For many retirees with $500,000–$5 million in investable assets, reducing the tax impact of RMDs can meaningfully improve their retirement cash flow and legacy goals. This topic is often part of a broader retirement or tax planning conversation. If you’d like help applying these ideas to your own situation, you can request an introductory conversation here.

Frequently Asked Questions

What age do RMDs start in 2026?
Most people are required to begin RMDs at age 73 if born in 1951–1959. For individuals born in 1960 or later, the RMD age will rise to 75 starting in 2033. Congress.gov

Can I avoid RMDs entirely?
No, you cannot avoid RMDs once you reach the required age, but strategies like Roth conversions, QCDs, QLACs, and delaying employer plan RMDs while working can reduce the tax impact.

Do Roth IRAs have RMDs?
No — Roth IRAs do not require RMDs during the account owner’s lifetime, making conversions a valuable planning tool.

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What To Do With Your CD Money

Posted On February 1, 2016 By Admin In Portfolio Management /   1 Comment

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If you’ve had CDs mature over the past several years, you’ve faced the unfortunate reality of having to choose between reinvesting into a new CD that pays a miniscule rate, or moving your money into riskier assets and giving up your guaranteed rate of return and safety. Although you can earn a higher coupon with corporate bonds than CDs, those investments are volatile and definitely not guaranteed. I understand the desire for many investors to keep a portion of their money invested very conservatively in ultra-safe choices. So, I checked Bankrate.com this week for current CD rates on a 5-year Jumbo CD and here is what is offered by the largest banks in our area:

Bank of America 0.15%
JPMorgan Chase 0.25%
Wells Fargo 0.35%
Citibank 0.50%
BBVA Compass 0.50%

While there are higher rates available from some local and internet banks, it is surprising how many investors automatically renew and do not search for a better return. Others have parked their CD money in short-term products or cash, hoping that the Fed’s intention of raising rates in 2016 will soon bring the return of higher CD rates.

Unfortunately, it’s not a given that the economic conditions will be strong enough for the Fed to continue to raise rates in 2016 as planned. This week, the 10-year Treasury yield dropped below 2%, which is not strong endorsement of the likelihood of CD rates having a major rebound in 2016.

This is the new normal of low interest rates and slow growth. While rates could be nominally higher in 12 months, it seems very unlikely that we will see 4% or 5% yields on CDs anytime in the immediate future. Waiting out in cash is a sure-fire way to not keep up with inflation and lose purchasing power.

What do I suggest? You can keep your money safe – and earn a guaranteed rate of return – with a Fixed Annuity. I only recommend Fixed Annuities with a multi-year guaranteed rate. Like a CD, these have a fixed interest rate and set term. At the end of the term, you can take your investment and walk away.

Today, we can purchase a 5-year annuity with a rate of 2.9% to 3.1%, depending on your needs. I know that’s not a huge return, but it’s better than CDs, savings accounts, Treasury bonds, or any other guaranteed investment that I have found. Since an annuity is illiquid, I suggest investors set up a five year ladder, where each year 20% (one-fifth) of their money matures. When each annuity matures, you can keep out whatever money you need, and then reinvest the remainder into a new 5-year annuity.

The beauty of a laddered approach is that it gives you access to some of your money each year and it will allow your portfolio to reset to new interest rates gradually as annuities mature and are reinvested at hopefully higher rates. In the mean time, we can earn a better return to keep up with inflation and keep your principal guaranteed.

Issued by insurance companies, Annuities have a number of differences from CDs. Here are the main points to know:

  • Annuities typically have steep penalties if you withdraw your money early. It’s important to always have other sources of cash reserves for emergencies. Consider an annuity as illiquid, and only invest long-term holdings.
  • If you take money out of an annuity before age 59 1/2, there is a 10% premature distribution penalty, just like a retirement account. A 5-year annuity may be best for someone 55 or older.
  • Money in annuity grows tax-deferred until withdrawn. If you rollover one annuity to another, the money remains tax-deferred. Most annuities will allow you to withdraw earnings without penalty and take Required Minimum Distributions (RMDs) from IRAs. Always confirm these features on an annuity before purchase.
  • While CDs are insured by the FDIC, annuities are guaranteed at the state level. In Texas, every annuity company pays into the Texas Guaranty Association, which protects investors up to $250,000. If you have more than this amount to invest, I would spread it to multiple issuers, to stay under the limit with each company.

If you have CDs maturing and would like to learn more about Fixed Annuities, please contact me for more information.

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The Year Ahead in Fixed Income

Posted On December 14, 2015 By Admin In Portfolio Management /  

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At the end of each year, we review the landscape for fixed income and equities, looking for opportunities and themes to use in our model investment portfolios. With this information, we adjust the weight of asset categories based on their relative risk/reward, and also decide which satellite categories offer the most interesting ways to enhance and complement our core holdings. This week, we start with a look at fixed income.

With today’s low interest rates, it should come as no surprise that the Aggregate Bond Index is only up 1.17% through December 11 this year. This small number belies the potential risks to the bond market in 2016, including the possibility for rising rates to crush long-term bond prices, falling credit quality and increased defaults in the energy sector, and the many unknowns about the rising US dollar and future inflation. And perhaps the only thing worse than seeing inflation tick up in 2016 would be seeing no inflation, a sign that the global economy could be moving back into recession.

The Federal Reserve is meeting on Tuesday and Wednesday this week, and many on Wall Street are watching to see if the committee is finally ready to raise the Fed Funds rate. This will likely be a major focus of the business news of the week, but in spite of all the attention paid to deciphering the Fed’s actions and comments, this is not a reason to be making knee-jerk reactions to Fixed Income holdings.

We see four major themes which will shape how we allocate to Fixed Income in 2016:

1) An emphasis on shorter duration. Whether or not the Fed raises rates this week, we are at a point in time at which the rates on 20-30 year bonds are artificially low. If we consider the yield to maturity as the potential reward for buying these bonds, then the risk we face in terms of a significant decline in price, as well as the opportunity cost to have purchased binds at a higher yield, is too great.

Within all our portfolios, we will look to reduce risk in our Fixed Income holdings, emphasizing shorter duration while maintaining or improving credit quality. We’re not interested in speculating on bonds, which is precisely what many investors are doing today with long-term bonds.

2) Sticking with high yield. We already have positioned our high yield holdings into a short duration fund, the SPDR Short-Term High Yield ETF (SJNK). SJNK has taken a beating this year, down 6.49% as of 12/11. While it’s easy to see the challenges facing high yield, the lower prices present a more attractive value than we’ve had in several years in the category. Today, the fund has an average maturity of only 3.12 years, an average bond price of $95.03, and a yield to maturity of 9.42%. In small portions, this short-term high yield position may help enhance our returns.

3) Municipal Bonds. Municipal Bonds have been held back by concerns about over-leveraged entities such as Detroit and Puerto Rico. At the start of 2015, munis were trading at a discount to other bonds, and that discount gave way to a strong performance in 2015. Even though they have come up in price somewhat, for investors in a higher tax bracket, municipal bonds remain very attractive compared to corporate or treasury bonds. For clients with large taxable holdings, we will likely add to municipal bonds in 2016.

4) Fixed Annuities. I’ve always admired the simplicity of a laddered portfolio of high quality bonds or CDs. In recent years, investors have gotten away from this approach, as they searched for higher yields elsewhere. Unfortunately, there is no free lunch – higher yields come with higher risks – and investors who always seek the highest yielding investments sometimes end up with losses rather than the high returns they had hoped for.

For investors who are 55 or older, who do not need liquidity from their holdings, consider creating a ladder of 5-year fixed annuities, buying one-fifth a year over 5 years. Today, we can buy a 5-year annuity at 3.10%, which is not bad for an investment with a guaranteed return. To get the same yield to maturity on a 5-year bond, we’d have to go a BBB-rated issuer or lower. The annuity may also be a good replacement for a CD, if you are disappointed with today’s rates when your CDs mature.

A laddered 5-year annuity portfolio could make sense for conservative investors because it offer a guaranteed rate of return, preservation of capital, and income, none of which are guaranteed with most other types of bonds. The main trade-off would be liquidity, but if you have a 5-year ladder, you’d have access to 20% of your principal each year. I’ve looked at other annuity durations, but feel that the 5-year is the sweet spot today. Shorter terms have a much lower interest rate, while longer terms do not see much of an increase over the 5-year product.

We will use these four themes to help customize each of our client’s fixed income holdings, even though changes to the model portfolios are likely to be relatively small. We have low expectations from fixed income for 2016 and the next several years. Our focus is not “how can we make as much as possible from bonds”. Rather, we view fixed income as a counter-weight to the risk we take in equities; its main purpose is to reduce the volatility of the overall portfolio. That’s why we want to be very careful about taking risks in fixed income at a time which might be the end of the falling interest rates which have boosted bond prices over the past 35 years.

Today, equities are near a high, even as the global economy struggles to sustain a recovery. Prices in fixed income are also at a high. This is a dangerous time for investors who have become greedy with yield in the recent period of rock-bottom rates. Once rates do begin to rise, fixed income will face a tough road, and that could become a very ugly situation if the stock market is also impacted by rising interest rates, decreased liquidity for corporations, and increased defaults.

Real Estate prices, fueled by cheap mortgages today, will also struggle to rise if homeowners cannot afford higher payments, and commercial Real Estate prices won’t be attractive to investors if cap rates are lower than bonds. I point this out not because I expect a crisis, but only because investors need to understand the potential impacts of higher interest rates in 2016 and ahead.

Next week: the outlook for Equities in 2016.

Source of data: Morningstar as of 12/14/2015

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