When inflation runs hot, savers and retirees are forced to make a choice. High inflation is a nightmare to those on fixed incomes who don’t have the ability to work or increase their savings rate. If your goal is to make your nest egg last as long as possible, high inflation is an insidious little tax on your assets and a loss of purchasing power you’ll never get back.

But there are two edges to this sword. In order to maintain your nest egg, you’ll need to undertake more risk to combat high inflation. On a fixed income, this is an uneasy proposition. A prolonged bear market would be worse for your savings than a period of high inflation, but the rates offered by safe and liquid vehicles like savings accounts won’t come close to matching inflation. So what’s a prudent saver to do? The answer may come in the form of safe, guaranteed products like a multi-year guaranteed annuity (MYGA). But like all financial products, annuities aren’t for everyone and MYGAs have special considerations to think about before purchasing.

How Do Annuities Work?

An annuity isn’t really an investment product. Think of it more like insurance – you surrender time and upside in exchange for a guaranteed return and minimal market risk. Annuities can be fixed or variable; fixed annuities aren’t subject to market risk and that’s the category that MYGAs fall into.

A fixed annuity has two phases: the accumulation phase and the payout phase. During the accumulation phase, the purchaser of the annuity makes payments to the insurance company offering the annuity. Depending on the structure of the contract, this accumulation phase could occur in a single lump-sum payment or in a series of payments over the course of a specific timeframe. Once the accumulation phase is complete, the owner of the annuity will receive their principal back, plus interest earned on the annuity.

MYGAs are often compared to certificates of deposit (CDs) since both products operate in a similar manner. Like a CD, an MYGA will require an upfront payment that you’ll need to lock the money away for a certain period of time in order to receive the maximum payout. But while CDs are often purchased with durations as short as 3 months or as long as 3 years, a MYGA is a product for those with longer time horizons, usually between 3 and 10 years. A 5-year MYGA is one of the more common types of contracts purchased from insurance companies.

Benefits of a Multi-Year Guaranteed Annuity

If you’re a risk-averse saver looking to maintain purchasing power in retirement, a MYGA can make a lot of sense. Here are some of the benefits of using a MYGA to preserve your nest egg.

No Market Risk – Since MYGAs are fixed rate products, you’ll receive the same amount of interest on your investment regardless of the stock market’s performance. If the S&P 500 drops 10% in a year, you won’t feel any of that pain since your rate is guaranteed over the life of the contract.

Tax Advantages – The interest that grows from a MYGA is tax-deferred, meaning you won’t owe Uncle Sam anything until you begin accepting payments from the annuity. A CD does not have this advantage. Unless held in a qualified account like an IRA, the interest generated by a CD is taxable each year. This is why CDs are more popular at shorter duration and MYGAs more suitable for those thinking of longer timelines.

Abundance – There’s no shortage of insurers offering MYGAs and plenty of variety when it comes to terms. You certainly want to shop around for the best rates, but also consider the length and stipulations of the contract. Some MYGAs even allow early withdrawals of interest, so cast a wide net when shopping for these annuities.

Drawbacks of a Multi-Year Guaranteed Annuity

While MYGAs may make sense in a number of retirement plans, they aren’t for everyone. Here are some downsides of annuities to consider before purchasing:

No FDIC Protection – CDs are offered by banks and secured up to $250,000 by the Federal Deposit Insurance Corporation, which means your principal is safe as long as the federal government doesn’t go under. That seems like a good bet. MYGAs and other annuities are offered by insurance companies, which have a much higher rate of failure. If the insurer fails, it will be up to the state to guarantee any funds from the annuities. Always consider the strength and reputation of the company offering the annuity before handing over any capital.

However, annuities can be protected by the Guarantee Association in the event that an insurance company becomes insolvent. If that insolvent company cannot provide assets to you, the Association may pay your claim in full, up to the protection limitation. In South Carolina, state law limits protection to an aggregate of $300,000 for all policies, except major medical health policies which have a limit of $500,000. Each state has its own fun and limits are differ between each state, so be sure to review your policy and research your state’s protection limit.

No Guarantee to Outpace Inflation – If you’re locking up money for a period of time, you’d want at least some promise that you’d beat inflation over the duration of the annuity. Unfortunately, preservation of purchasing power isn’t guaranteed. Very few (if any) individuals can predict interest rates and inflation with any regularity and its possible the rate you lock in today won’t even keep pace with inflation for the duration of the contract.

Make MYGAs Work for You

Products like MYGAs are definitely geared toward a specific demographic. Young, employed individuals and risk-tolerant investors won’t have much use for a MYGA unless they’ve maxed out all other tax deferred options. But if you’re nearing retirement, maxing out your 401(k), and want an additional tax-advantaged product, MYGAs are something worth considering.

Disclosures

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.

Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.