CDs, Treasuries, annuities and structured products each do a different job
Many retirees keep a meaningful share of their savings in cash or CDs because it feels safe. That's understandable. After years of saving, avoiding a large loss can feel more important than chasing another gain.
But safe money still needs a plan. Before choosing where to keep it, ask what the money is for, when you'll need it and what it may cost you to keep it there. A vehicle that works well for next month's expenses may not be the right fit for money earmarked five years from now.
The rate environment has also shifted. As of publication, the 10-year Treasury yield has reached its highest level in more than two decades.¹ Rates offered on CDs, Treasuries and fixed annuities generally move with that broader environment, which can make locking something in feel urgent. A higher rate is worth considering, but the job the money needs to do still comes first.
What job does your safe money need to do?
Safe money usually has one of three jobs. It may be an emergency reserve for an unexpected home repair or medical bill. It may fund planned withdrawals during the next one to five years. Or it may provide enough stability to help you leave the longer-term portion of your portfolio invested when markets are unsettled.
Those jobs call for different levels of access, predictability and protection. Emergency reserves generally need ready access. Money for a known expense can often be matched to a specific maturity date. Funds intended for later years may allow more flexibility, but only if the rest of the retirement income plan is coordinated around them.
That's why the decision should not begin with which account is paying more today. It should begin with the job, the time frame and the consequence if you need the money sooner than expected.
How do CDs work, and what are their limits?
A certificate of deposit holds money for a stated term and generally pays interest under terms set when the CD is opened. CDs issued by an FDIC-insured bank may qualify for federal deposit insurance up to $250,000 per depositor, per insured bank, for each ownership category.²
That protection takes a little more attention than keeping each CD below $250,000. The FDIC combines deposits held in the same ownership category at the same insured bank, including deposits at different branches. Account registration, accrued interest and other deposits at that bank can affect how much is covered.²
The tradeoff is access. A bank CD may impose an early withdrawal penalty, while a brokered CD may need to be sold in the secondary market. If it's sold before maturity, its value can be higher or lower than the amount originally deposited.
CD interest is generally subject to federal income tax. For a CD with a term longer than one year, a portion of the interest may need to be reported as income each year, even when it will not be paid until maturity.³
How are structured CDs different from traditional CDs?
Structured CDs, sometimes called market-linked or indexed CDs, connect interest to the performance of a reference asset such as a market index. Instead of a conventional fixed rate, the return is determined by a formula in the offering terms. That formula may include a participation rate, a maximum return, an averaging method or other conditions that limit how much of an index gain is credited.⁴
A structured CD can be a deposit eligible for FDIC insurance when the issuing bank guarantees the principal and the other FDIC requirements are met. If the principal itself is subject to market loss, the product is not an insured deposit. Coverage also remains subject to the depositor's combined balances, insured bank and ownership category.⁴
That does not mean every amount shown on a structured CD statement is insured at every point. Some products credit market-linked interest only at maturity. If the issuing bank fails before that interest has accrued, the uncredited amount may not be covered.⁴
Access can also be limited. A structured CD may be designed to be held until maturity, and its secondary-market value can be uncertain. Before committing money, understand whether early withdrawal is allowed, whether the bank can call the CD, how the return is calculated and what happens if the linked index is flat or declines.
What about Treasuries and money market funds?
Treasury bills, notes and bonds are obligations of the U.S. government. Their interest is subject to federal income tax but exempt from state and local income tax, which can matter for New Jersey residents.⁵
A Treasury held to maturity provides a defined maturity value. If it's sold before maturity, its market price may be higher or lower than its face value. The longer the time to maturity, the more price movement may matter when access is needed early.
Money market funds take a different approach. They're mutual funds that generally invest in liquid, short-term debt securities, cash and cash equivalents. They often provide convenient daily access, but they're not bank deposits and they're not FDIC insured. Although these funds seek stability, they can lose value.⁶
Don't confuse a money market fund with a bank money market deposit account. A qualifying deposit account at an FDIC-insured bank may receive FDIC coverage within applicable limits. A money market mutual fund does not.⁶
What is a fixed annuity, and how is it different?
A multi-year guaranteed annuity is a long-term insurance contract that credits a fixed rate for a stated term. Its growth is generally tax deferred until money is withdrawn.⁷
The tradeoff is liquidity. A fixed annuity may impose surrender charges when withdrawals exceed the contract's permitted amount during the surrender period. Some contracts allow limited withdrawals without a surrender charge, but the provisions vary and should be reviewed before purchase.⁷
That makes the comparison with a CD more than a comparison of credited rates. A CD is a bank deposit that may qualify for FDIC insurance. A fixed annuity is an insurance contract that offers tax deferral but may restrict access for several years. Fixed annuity guarantees are backed by the claims-paying ability of the issuing insurance company, and annuities are not FDIC insured.
Are structured notes really safe money?
Structured notes are securities whose return is tied to one or more reference assets, such as an equity index, a group of stocks or another market measure. Unlike a structured CD that qualifies as an insured bank deposit, a structured note is generally an unsecured debt obligation of the issuer and is not FDIC insured.⁸
The terms can vary widely. Some notes provide full or partial principal protection at maturity, while others expose the investor to substantial principal loss. Any protection depends on the issuer's financial health, and some protections apply only when the note is held to maturity.⁸
Structured notes may also cap gains, use complex payoff formulas or allow the issuer to call the note early. A secondary market may be limited or unavailable, so selling before maturity can result in receiving substantially less than the original investment.⁸
For those reasons, a structured note should not automatically be labeled safe money. Before it has a place in a retirement plan, the investor should understand the downside calculation, issuer credit risk, maturity, call terms, liquidity and the conditions attached to any principal protection. FINRA has specifically highlighted the complexity and concentration risk of certain structured notes that do not protect principal.⁹
Why does age 59½ matter?
Withdrawals from a nonqualified annuity are generally treated as earnings first. The taxable portion of a withdrawal taken before age 59½ may also be subject to a 10% additional federal tax unless an exception applies.¹⁰
That's one reason a fixed annuity generally fits money that won't be needed before age 59½ or during the contract's surrender period. Fixed annuity guarantees are backed by the claims-paying ability of the issuing insurance company.
Age is only part of the decision. Even after age 59½, a withdrawal can still create ordinary income tax and a surrender charge. The money's purpose and expected timing should be clear before funds are committed.
How can these options work together in a retirement income plan?
A retirement plan does not need one answer for every safe dollar. A readily accessible bank account or money market fund may cover emergencies. A ladder of CDs or Treasuries can stagger maturity dates so funds become available when planned expenses are expected. Longer-term options may be considered only after near-term liquidity has been addressed.
This is where retirement income planning matters. Each dollar can be matched to a job and a time frame, then coordinated with Social Security, pensions, required distributions and the order in which accounts will be used.
The safe allocation should also support the rest of the portfolio. Knowing that several years of planned withdrawals are set aside may make it easier to avoid selling growth investments during an unfavorable market. The amount set aside still needs to reflect spending, taxes and how much you can safely withdraw in retirement.
What should you ask before moving money that's coming due?
· When will I need this money?
· What happens if I need it earlier than planned?
· Is my principal protected, and under what conditions?
· Is it an FDIC-insured deposit, a government obligation, a mutual fund, an insurance contract or an unsecured obligation of an issuer?
· How is the return calculated, limited or capped?
· Can the bank or issuer call it before maturity?
· How will the interest, growth or withdrawal be taxed?
· How does it fit with my retirement income plan?
If you have CDs maturing or cash sitting idle, our advisors are happy to review where it fits in your plan. Schedule a complimentary, no-obligation review.
Sources
1. Board of Governors of the Federal Reserve System
2. Federal Deposit Insurance Corporation
3. Internal Revenue Service
4. Federal Deposit Insurance Corporation
5. Treasury Direct
6. U.S. Securities and Exchange Commission, Investor.gov
7. National Association of Insurance Commissioners
8. U.S. Securities and Exchange Commission, Investor.gov
9. Financial Industry Regulatory Authority
10. Internal Revenue Service
This article is for educational purposes only and should not be considered individualized investment, tax or legal advice. Advisory, planning and brokerage services may differ in cost, scope, standard of care, compensation structure and conflicts of interest. Review your situation with a qualified financial professional before making decisions.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.
Fixed annuities are long-term insurance contracts. Guarantees are backed by the claims-paying ability of the issuing insurance company. Annuities are not FDIC insured. Withdrawals may be subject to surrender charges and, if taken before age 59½, a 10% additional federal tax.