Broker Check

ALTERNATIVES TO CERTIFICATES OF DEPOSIT: COMBATING HISTORICALLY LOW INTEREST RATES

February 08, 2017

Are you like many Americans who may be looking for an alternative to low yielding Certificates of Deposit?

Dear friend, As a financial professional, lin constantly asked “where is the best place to invest my money?” Ws a challenge that those of us in the business of trying to help people manage their money face everyday. Are you readyfor a refreshing bit of truth? The fact is, no one really knows what will be the best in the future, and ifanyone that you are working with tries to suggest that they do, you may wish to run hastily awayfrom them. Why is this? Think about it… why is it that we never see the following headlines in the newspaper:

“Local Psychic Wins the Lottery”
or
“Fortune Teller Cleans Out Casino”

Nobody can predict the future. One can make some educated guesses about what may happen. They may even draw from history in order to do so. But, when it comes to attempting to answer the question “Where is the best place to invest my money?” the answer might just be “It depends.”

So what does it depend on? It really depends upon your individual circumstances and many things that are out of your control. For the purposes of this report, let’s assume that you are looking for an alternative to a Certificate of Deposit. Before we discuss any alternatives, let’s look at the advantages and disadvantages of Certificates of Deposits (CDs).

 

Advantages:

  • CDs are safe. They are FDIC insured up to $250,000, which means the federal government insures the principal.
  • They are predictable. One knows exactly what they will get out of a CD when they purchase one because the interest earned is a constant, unlike some financial instruments.
  • CDs can be used as a good income generating tool. Many retirees utilize the interest from their CD as their retirement income.
  • They are fairly liquid. If one really needed access to the entire sum of money that they deposit in a CD, they could, but accessing that money may force you to pay some sort of penalty, usually in the form of forfeiting interest gained. So, while they aren’t 100% liquid, one can usually have access to the entire principal amount without too much difficulty.

Disadvantages:

  • In a low interest rate environment, CD rates can be very low. This presents challenges for retirees who rely on that income when it comes time to “renew” a CD in a low interest rate environment.
  • Time commitment. CDs require you to commit your money for a certain period of time. If interest rates become more favorable, you don’t get the benefit of those higher rates.
  • Taxes. CD interest is 100% taxable, regardless of whether one utilizes this interest as income. For example, if you purchase a $100,000 CD with 4% interest, the interest will be $4,000. If you are in a 25% income tax bracket, this means that your “net income after taxes” is $3,000. So, this means that your net effective yield is only 3%.
  • Inflation. It is possible when you save with CDs that you may not be able to keep up with inflation. While this is true of other financial instruments, since one never knows what will happen in the future, this becomes a real threat for retirees that utilize CDs.
  • Social Security Income Taxation. For many retirees, CD income can adversely affect the level of taxation on their social security benefits. So, in addition to the above mentioned disadvantage with regards to taxation, there could potentially be an adverse affect on how much of ones Social Security benefits are taxed, due to interest income accrued from CDs.

As the title of this report suggests, the goal is to introduce you to some potential alternatives to CDs, in light of a historically challenging interest rate environment. Please keep in mind that this information is not to be construed as advice. As suggested earlier, the proper solution for your situation really depends on your individual circumstances. One really needs to consider what their goals are with their money before making any decisions, and keep in mind that there is not a universal answer to the question “Where is the best place to invest my money.”

Let’s explore some of the alternatives to CDs:

BONDS

One way to invest is to lend your money to others; this is the very nature of a bond. There are various types of bonds, but the main difference lies in who you are lending your money to. In exchange for allowing an entity (bond issuer) to borrow your money, they agree to make interest payments to you. At the end of your “loan term,” they agree to pay back your initial principal. Sounds simple, right? In a perfect world, bonds are great vehicles for people to use as income. But, as we all know, we don’t live in a perfect world. There are risks associated with buying bonds. The largest risk comes down to “who you are going to ‘lend’ the money to.” Lending money to the government usually consists of much less risk than lending money to a small company. The tradeoff between the two is that the government will likely “borrow” money at lower interest rate than the small company will. This is a risk the investor assumes in return for a potentially higher interest rate. Let’s look at the advantages and disadvantages to bonds:

Advantages:

  • Bonds tend to offer higher interest rates compared to short-term investments, such as money markets and CDs.
  • Bonds carry less risk than stocks, and may do a more efficient job than CDs in keeping up with inflation.
  • They can be used as a good income generating tool during retirement.
  • Since bond prices change as the interest rate environment changes, if the interest rate environment moves down, one could sell their bond at a premium, resulting in an investment gain.
  • Liquidity. Bonds can be sold in the open market. This makes them a fairly liquid investment; however what one receives in return for selling the bond can vary drastically from what they originally invested.

Disadvantages:

  • Selling bonds before their maturity may result in a loss (this is known as selling at a “discount”)
  • Bonds often have much longer maturities than CDs, often times anywhere from 5-30 years.
  • There is risk associated with bonds that many CD owners don’t feel comfortable with. The varying levels of risk depend upon the quality of the bond issuer. Default risk is one of the risks that investors assume; this refers to an issuer’s failure to make payments.
  • When an issuer fails to make payments, the income stream that a retiree counted on being there may be in jeopardy.
  • Taxation. How one is taxed on bond income really depends upon the type of bond that one purchases. Bonds may face the same challenges with regards to income taxation and social security benefit taxation that CDs do. It is important to carefully review the taxability consequences of the various bonds one might consider purchasing.
  • Bond yields can move up & down, so if utilizing for income, this may cause that income to fluctuate. ❑ Bonds are not insured by the FDIC and could lose value.

Money Markets

Another common alternative to a Certificate of Deposit is a Money Market Account/Fund. It is quite likely you were given this as an option when you initially purchased your CD. Money Market Accounts are offered by banking institutions, thus providing the same amount of FDIC insurance as CDs. Money Market Funds are offered by investment companies, and do not provide FDIC insurance. Let’s look at the advantages and disadvantages to considering a Money Market:

Advantages

  • Money Markets are very liquid, and USUALLY have lower charges associated with investing in them or taking your money out.
  • Generally speaking, money markets are considered to be a very safe investment vehicle; thus making their rates of return somewhat predictable.
  • They can be purchased through banks and most investment institutions.

Disadvantages

  • The rate of return from a money market is likely going to be less than that of a Certificate of Deposit. This is viewed as one of the tradeoffs for the added liquidity.
  • Although the rate of return is somewhat predictable, it can fluctuate throughout the time in which you own a money market fund. Unlike when you purchase a CD, you don’t “lock in” to a certain length of time when you purchase a money market fund. This can work to your disadvantage if rates are trending down, but also be advantageous if the interest rate environment is trending upwards.
  • Inflation. It is possible when you save with money markets that you may not be able to keep up with inflation.
  • Taxation. Interest generated from money markets is taxable at ordinary income tax rates, regardless of whether you plan to utilize that interest income or not.

Money Market accounts/funds are often places where people will place their emergency cash or “just in case” cash. They tend to offer slightly higher rates of return than a bank savings account while providing a similar level of safety and liquidity. For the purposes of why many may have requested this report, you may wish to consider having some short term dollars in a money market; but from a long term perspective, there may likely be higher yielding options that you’d potentially fair better with. However, it is important to take your entire financial picture into consideration before making that decision.

Annuities

The term “annuity” is derived from the Latin word “annus,” which means “annual or yearly.” Over the years, annuities have been given a bad reputation. This may be because they are largely misunderstood by the general public, or because of unscrupulous insurance agents who may have misrepresented them. Let’s be clear – annuities are not for everybody. These financial tools are specifically geared for retirement. Further complicating the matter is the fact that there are a number of various types of annuities in the marketplace. And they are not all created equal. For the purpose of this report, we’ll shed some light on the most common types of annuities, and share with you the good, the bad, and the ugly for each.

Immediate Annuities

This is one of the most basic forms of an annuity. Remember, at the core of an annuity is income. As the name suggests, an immediate annuity is one that is going to provide income to you immediately. Think of an immediate annuity as the exact opposite of life insurance. For example, with life insurance, you pay an insurance company a certain amount of money annually in exchange for them agreeing to pay your beneficiaries a lump-sum of money when you die. An immediate annuity functions exactly the opposite of life insurance; you give an insurance company a lump-sum of money in exchange for a series of income payments to you. Immediate annuities are a very commonly used tool for generating income in retirement years. Furthermore, there are a number of variations with immediate annuities in terms of the income you receive. For example, some immediate annuities will pay you income for the remainder of your life, no matter how long you live. Some immediate annuities will pay you an income stream for a set number of years. There are many variations to these, and it is important to review the differences with a financial professional. Let’s explore the advantages and disadvantages to immediate annuities:

Advantages

  • Lifetime immediate annuities may provide you with an income stream that you can’t outlive.
  • There may be certain tax advantages to immediate annuities, as a percentage of the income payments may not be taxable, as they are considered a “return” of your initial investment (premium).
  • Immediate annuities provide predictable and contractually guaranteed income payments.
  • Purchasing a life-only immediate annuity may provide a higher amount of income than that which you can find with other financial vehicles; for those that need the most amount of income from a particular chunk of money, immediate annuities may be a viable financial tool to consider.

Disadvantages

  • Immediate Annuities are not insured by the FDIC.
  • When you purchase an immediate annuity, you are making an irrevocable decision. In essence, you are entering into a contract with the insurance carrier whereby you exchange a sum of money for a series of income payments.
  • One tradeoff with immediate annuities is liquidity. Generally speaking, when you purchase an immediate annuity, you forfeit access to this money in exchange for the guaranteed income payments.
  • With lifetime immediate annuities, one doesn’t really know what their rate of return is going to be. They know what their income will be, but not necessarily their rate of return. Frankly speaking, what you get out of this type of annuity over the long term really depends upon when you were to die. If you passed away early in the contract, your return on your “investment” would be considered much worse than if you lived much beyond your life expectancy. When you purchase an immediate annuity, you are likely doing it for the income payment and not so much the rate of return.

Fixed Annuities

As the name suggests, a fixed annuity has a fixed interest rate attached to it. Unlike an immediate annuity, the owner of a fixed annuity still retains control of their assets, rather than “trading in” their dollars for an income stream. The fixed annuity contract is with an insurance company, whereby they guarantee a specified rate of return over a period of time.

Advantages

  • Often times, the interest rates an individual can receive from a fixed annuity are higher than from a Certificate of Deposit or Money Market. ❑ The dollars placed into a fixed annuity are contractually guaranteed by the claims paying ability of the underlying insurer. (Be sure to choose your insurance company wisely).
  • If you don’t wish to take the interest as income, you can defer taxes on that income.
  • Generally speaking, you know what you will receive in terms of interest. There are different types of fixed annuities, some offer guaranteed interest rates for a set period of time (similar to a CD), while others offer a different interest year after year depending upon the current interest rate environment (similar to a money market account).
  • Many fixed annuities have “free withdrawal” provisions which may allow you to access a certain percentage of your money without incurring surrender charges/penalties. Commonly, this is up to 5 or 10% annually.
  • Annuities can avoid probate, as a properly selected beneficiary is what determines who will receive the assets upon the death of the annuity owner.
  • Fixed annuities offer the owner many different income and withdrawal options that other financial products don’t.

Disadvantages

  • Fixed Annuities are not insured by the FDIC.
  • Annuities are retirement vehicles. If you attempt to withdraw money from them before age 59 1/2, a 10% excise penalty will likely apply.
  • Most annuities have early surrender penalties. Simply put, this means that if you wanted to access more money than is contractually allowed or move all of the money before the contract period is up, you would likely incur a penalty to do so.
  • Much like CDs, when you place money into an annuity, you are agreeing to keep it there for a specified amount of time. This is where early surrender charges would apply. Typically speaking, contract lengths are between 5 and 10 years.
  • Unlike stocks and some other investments, annuities do not receive a “step-up” value at death when your beneficiaries receive the money. Ordinary income taxes would be due on the gain in the annuity.

Fixed Indexed Annuities

As the name suggests, a fixed indexed annuity is another version of fixed annuity, but it has one added component – it is linked to a market index. Often times, the fixed indexed annuity interest rate is linked to some sort of equity index, such as the S&P 500 or the Dow Jones Industrial Average. This is the reason why these vehicles are often called equity-indexed annuities. However, there are indexed annuities that are linked to bond indices as well. This type of annuity is different from other fixed annuities because of the way in which it credits interest to your account. Interest is credited to your account based upon a formula that is linked with the market index.

Generally speaking, you will be able to participate in some of the upside of the index gains. However, since it is a fixed annuity, there are contractual guarantees that safeguard the account from the downside of the stock market index. It is important to note, however, that you are never actually invested in the stock market. Any dollars you put into a fixed indexed annuity would be a part of an insurance contract with the insurance company, as opposed to a direct investment in any sort of stock market index. This helps protect the consumer from the downsides that can come with the market. There are many indexed annuities available in the marketplace, and many of them have different formulas for crediting interest. Make sure that you understand the formula for interest crediting before you purchase an indexed annuity.

Advantages

  • Indexed annuities offer the opportunity for higher upside potential than most fixed annuities or CDs, without the direct risk of stock market losses.
  • The dollars placed into an indexed annuity are contractually guaranteed by the claims paying ability of the underlying insurer. (Be sure to choose your insurance company wisely).
  • If you don’t wish to take the interest as income, you can defer taxes on that income.
  • Most fixed index annuities have “free withdrawal” provisions which may allow you to access a certain percentage of your money without incurring surrender charges/penalties. Commonly, up to 5 or 10% annually.
  • Annuities can avoid probate, as a properly named beneficiary form is what determines who will receive the assets upon the death of the annuity owner. o Fixed annuities offer the owner many different income and withdrawal options that other financial products don’t.

Disadvantages

  • Fixed Indexed Annuities are not insured by the FDIC. o Annuities are retirement vehicles. If you attempt to withdraw money from them before age 59 1/2, a 10% excise penalty will likely apply.
  • Fixed index annuities can be complex because there are a number of various crediting methods (formulas for how interest is determined). This added layer of complexity makes it more important for consumers to understand the contracts they are considering.
  • Most annuities have early surrender penalties. Simply put, this means that if you wanted to access more money than is contractually allowed or move all of the money before the contract period is up, you would likely incur a penalty to do so.
  • Much like CDs, when you place money into an annuity, you are agreeing to keep it there for a specified amount of time. This is where early surrender charges would apply. Typically speaking, contract lengths are between 5 and 10 years.
  • Unlike stocks and some other investments, annuities do not receive a “step-up” value at death when your beneficiaries receive the money. Ordinary income taxes would be due on the gain in the annuity.

Variable Annuities

Generally speaking, a variable annuity would not be a common alternative for a CD. This is because variable annuities consist of mutual funds which may have substantial fluctuation and subject your principal to risk. This is not to say that a variable annuity is a bad thing, necessarily.
Simply put, however, it is not a common alternative to a CD because in its purest form a variable annuity lacks the safety component associated with most of the other alternatives we have introduced. The growth inside of a variable annuity is directly associated with the underlying investments that make up the sub-accounts. These underlying investments are usually mutual funds, which consist of direct stock market risk.

However, the reason variable annuities were mentioned is because of something called riders. Many variable annuities, fixed annuities, and fixed indexed annuities have riders available on them. A rider is simply a separate (usually optional) feature attached to the base contract that offers some sort of additional benefit or coverage. Generally speaking, riders come with a fee attached to them for the enhanced benefit or feature you may receive with the contract. There are a number of riders available on annuities, and they are beginning to pick up a lot more attention, as of late, because of some of the extra assurances that they offer the client. Let’s explore a couple of the common riders available on many annuities:

Guarantee Income Benefit Riders

There are a number of variations of this type of rider. Generally speaking, this rider establishes a “separate” account from the “accumulation account”, known as the “income account” This account will grow at a certain guaranteed interest rate while you are waiting to trigger income. Often times, this interest rate may be anywhere from 4-8% per year. This sort of benefit is beneficial for people who plan to take income from their account at some point in the future. However, there are usually restrictions in the way that you can access this account. As the name implies, you have to use this guaranteed income account for income purposes. Most insurance companies will allow a certain Guaranteed Withdrawal percentage to come out of this account; this withdrawal percentage is usually dictated by your age. For example, at age 60, you may be able to take out 5% of the income account value, while at age 75, they may allow you to take out 6%. Usually, this withdrawal rate/amount is able to be taken out for the rest of your life, no matter what happens in the interest rate environment, the stock market, the value of your “accumulation account” or how old you live to be. These riders offer the consumer the ability to take out a certain amount of money dictated by the contract without having to worry about the effect that day-to-day fluctuations in the stock market or interest may have on their portfolio.

Death Benefit Riders

Much like the income benefit riders, there are many different variations to death benefit riders. This type of rider may offer a minimum interest rate growth on your account should you pass away before needing to access it. Or, in the case of a variable annuity, it may offer the death benefit to be whatever the highest amount that your sub-account investments grew to, in the event of a market decline. Again, there are a number of these types of riders available, so make sure to fully understand the costs and features of any rider you are considering.

Nursing Home or Long Term Care Riders

The last rider that we’ll discuss is a nursing home or LTC rider. This rider may provide enhanced benefits on your account should you need Long Term Care or are confined to a nursing home. These riders can be very beneficial for people who may have concerns about protecting their portfolio against a long term care.

Other Investments

This informational booklet was not designed to be an all-encompassing solution to financial planning. It is simply an informative guide to help you navigate through the decision making process if you are considering some alternatives to the traditional Certificate of Deposit. We did not introduce a number of other investment vehicles that you may also hear about. Some examples might be individual stocks, mutual funds, gold, real estate or unit investment trusts. All of the aforementioned investments likely carry much more inherent risk than that of a traditional Certificate of Deposit, which is the main reason why we left them out of the discussion for the purposes of this booklet.

 

So what’s the next Step?

Your receipt of this report entitles you to a no cost or obligation one hour session to explore more of the details of CD alternatives. Interest rates change very frequently, so publishing rates in a booklet like this would not be prudent a wise. This is why we encourage you to take the next step and join us for an hour. Any customary hourly planning fees will be waived for this one hour session.

What should you expect at this one hour session? Below are some frequently asked questions about what we call the “59 Minute Financial Wellness Consultation.”

Q: What will this meeting consist of?
A: This meeting is simply an opportunity for you to ask any questions that you may have related to Certificates of Deposit, alternatives to CDs, as well as your personal finances and retirement. Throughout the course of the meeting, we will ask questions about you and your situation. We’ve found that everybody’s definition of a comfortable retirement is a little
different, and that everybody’s situation is unique. Our goal is to learn about your personal goals as we explore how to help you retire the way you want.

Q: Why do you offer this no cost or obligation consultation?
A: Simple. It gives us an opportunity to meet folks from around the area that may have questions about financial matters. It’s no secret that we would love new clients. Gaining new clients is the may that our business grows. However, we want to provide a comfortable environment for exploring a new, potential professional relationship — for you and for us. By offering an hour of our time for no cost or obligation, it provides a non-threatening way fa us to spend some time with you to see if it makes sense for us to continue discussions into the future.

Q: Will there be a sales presentation?
A: Not at all. In fact, we are very hesitant to talk about any potential solutions to any questions or concerns you may have. It is important fa us to understand your goals and desires about what “retiring” or “investing for your future” means to you. We feel it would be financial malpractice to begin exploring solutions prematurely. We tend to look at the first meeting as an opportunity for you to ask some questions, and for us to get to know each other. Furthermore, we can both be more informed by the end of the meeting, which will help determine whether or not it will be beneficial for us to meet again.

Q: How long will the meeting last?
A: About 59 minutes. Most of our meetings are stacked throughout the day. Future sessions may require more time, but we’ve found that an hour, initially, provides a good basis for getting to know a little more about each other.

Q: What should I bring to the meeting?
A: We are sensitive to the fact that your personal financial information is just that — very personal. However, it is hard for us to help if we don’t, at least, have a fundamental understanding of your financial position. We ask that you bring information regarding your financial accounts, and your previous year’s tax return. However, we follow a pretty strict policy of not looking at any of this until you are comfortable with us doing so.

Q: What will happen after the meeting?
A: If we both decide that it would be beneficial to meet again, we’ll schedule another time to get together. That meeting we would introduce to you the various areas in which our firm may be able to provide value to your situation. Again, there would be no solutions offered at the second meeting. That would still be a discovery meeting. At that point, you should be in a better position to make an educated decision as to whether you wish to engage the services of our firm.

Q: Who should come with me?
A: We do ask that if you are married, you bring your spouse with you. If you wish to bring any children with you to the meeting, you are welcome to do so. For that matter, anybody that you may utilize in helping you with your retirement and personal finances is welcome to join.

Some important disclosures about the content discussed in this booklet:

*FDIC-member accounts, including CDs, checking, savings, money market and certain retirement accounts. are insured up to 5250,000 per depositor, per insured bank, for each account ownership category. CDs may be subject to early withdrawal penalties.

**CD’s and many of the alternative investments mentioned in this report, including annuities, have many different features, costs, early surrender penalties and withdrawal and/or liquidity options that should be considered prior to making any investment decisions.

***Annuities are best suited for longer term investing and there may be surrender charges, fees, and other costs associated with annuities, plus a 10% tax penalty for withdrawals made prior to age 59 ‘A. Guarantees offered by annuities are based on the claims-paying abilities of the underlying insurance companies. Index annuities may include, but are not limited to, asset fees, participation rates, caps and/or contingent deferred sales charges. Credited interest on index annuities are based upon a formula linked to the corresponding stock market index and may be more or less than the actual index performance.

****Investing in stocks, bonds, mutual funds, variable annuities and some money market accounts carries an inherent clement of risk and there is the potential for loss of principal. Past performance is no guarantee of future results and actual results may vary. There may be additional fees and charges associated with investing in securities.
When considering an investment, please review any/all related and required corresponding information, documentation, and material including, but not limited to: prospectuses, illustrations, disclosures, disclaimers, suitability forms, acknowledgment forms, etc., which should be reviewed to help determine all product specific features, benefits, riders, costs, and potential surrender charges. All alternatives mentioned within this report are not FDIC insured.