Multi-Year Guaranteed Annuity (MYGA)

Buying a MYGA is one strategy for generating added income in retirement to supplement investment accounts and Social Security benefits.

MYGAs offer a potentially safer way to grow your money, and you won’t owe taxes on the growth until you start taking payments.

They are also known as CD-type annuities because they share some of the benefits of certificates of deposit, such as time horizon for the investment and a guaranteed fixed interest rate.

With a MYGA, you sign a contract with an insurance company in which you pay the insurance company a premium in exchange for a guaranteed fixed interest rate on the contribution for a specified period of time. The term can be three years, five years, 10 years or any number of years in between.

A MYGA works by tying up a lump sum of money to allow it to accumulate interest. If you need to withdraw money from an annuity before the accumulation period is over, you may have to pay fees called surrender charges. Depending on the annuity provider, your contract may include penalty-free withdrawal provisions that allow you to make partial withdrawals before the surrender period ends without incurring fees.

At the end of the accumulation period, you can receive the premium and interest earned, or you may be able to renew the contract. If you choose to renew the contract, the interest rate may differ from the one you had originally agreed to.

Another option is to transfer the funds into a different type of annuity. You can do so without facing a tax penalty by using a 1035 exchange.

Because interest rates are set by insurance companies that sell annuities, it’s important to do your research before signing a contract.

The first step is to consult a financial advisor and determine how much you would like to invest in an annuity. Then, it’s time for comparison shopping: Look at various highly rated insurance companies to see the MYGA rates they offer.

To better understand how an individual nearing retirement might benefit from a MYGA, let’s look at a case study example.

People who purchase MYGAs are usually looking for a risk-free way to grow their savings in preparation for retirement. These individuals “may be pre-retirement or bridging the gap across retirement,” according to Annuity.org expert contributor Stephen Kates, CFP®.

Kates, who is a Certified Financial Planner™, said that a typical MYGA customer is someone who doesn’t want to risk exposing their savings to the market as they are very close to retirement, but still wants to grow their savings to provide more income after they retire. MYGAs are also well suited to planning exactly how much income you’ll receive, as the interest rate is constant throughout the annuity’s term.

Current MYGA rates change daily and vary slightly from carrier to carrier. In early-September 2022, the best rate for a MYGA with a 10-year surrender period was 4.50%, and the best rate for a MYGA with a seven-year surrender period was 4.60%. The best rates were 4.40% and 3.9% for MYGAs with five-year and three-year surrender periods, respectively.

MYGA rates are usually higher than CD rates, and they also compound each year. A contract with more limiting withdrawal provisions may have higher rates.

MYGAs are subject to surrender charges, which means annuity holders may be obligated to pay fees if they want to take money from an annuity before the term is up.

Many annuity providers offer penalty-free withdrawal provisions that allow you to withdraw some of the money from an annuity before the surrender period ends without having to pay fees. Some contracts, for example, allow you to withdraw up to 10 percent starting in the first year.

Withdrawal provisions for MYGAs depend upon the terms of each contract. But you can generally take out a specified portion of funds during the term without any penalties. Details are spelled out in the annuity contract.

Your contract may also allow you to take money out for emergencies. For example, if you need money to pay a hospital bill, you may be able to take it out of your MYGA. This may be better than getting a 401(k) loan or withdrawing funds from an IRA.

But before pulling money out of a MYGA early, consider that one of the major benefits of a MYGA is that they grow tax-deferred.

A MYGA offers tax deferral of interest that is compounded on an annual basis. This can create additional wealth exponentially because the tax occurs only when you take the money out. It’s like investing in an IRA or 401(k) but without the contribution limits.

The tax rules change slightly depending on the type of funds you use to purchase the annuity. If you purchase a MYGA with qualified funds, such through an IRA or other tax-advantaged account, you pay income tax on the principal and interest when you take out money, according to CNN Money. If you purchase a MYGA with nonqualified funds, you pay taxes only on the interest.

This tax benefit is not unique to MYGAs. It exists with traditional fixed annuities as well.

MYGAs are a type of fixed annuity. The main difference between traditional fixed annuities and MYGAs is the period of time that the contracts guarantee the fixed interest rate.

MYGAs guarantee the interest rate for the entire duration of the contract, which could be, for example, 10 years. Traditional fixed annuities may guarantee the interest rate only for a portion of the term of the contract. So, you may buy an annuity with a seven-year term but the rate may be guaranteed only for the first three years.

When people speak of MYGAs, they usually liken them to CDs.

Both MYGAs and CDs offer guaranteed rate of return and a guaranty on the principal.

An MYGA works very similarly to a CD — you deposit a lump sum of cash and receive a fixed interest rate for a specific period of time on both a MYGA and a CD. Compared to investments like stocks, CDs and MYGAs are safer but the rate of return is lower.

They do have their differences, however.

You could use a MYGA as a substitute for a CD, or you could incorporate both into your financial plan.

As with any financial product, you need to see what your financial goals are prior to purchasing a MYGA.

Given the conservative nature of MYGAs, they might be more appropriate for consumers closer to retirement or those who prefer not to be subjected to market volatility. While potentially suitable for a highly risk averse investor, a MYGA may not be suitable for a younger investor interested in growth.

For those who are looking to outpace inflation, a MYGA might not be the best financial strategy to meet that objective.

If you are looking for a solution to replace your income upon retirement, other types of annuities may make more sense for your financial goals. Moreover, other types of annuities have the potential for higher reward, but the risk is higher, too.

Bottom line is you need to look at what is most important for your financial objectives.