Multi-Year Guaranteed Annuities (MYGA’s) Explained

To make sure everyone’s on the same page, I’ll start with defining Annuities themselves in very brief, as it is a large enough category of investments that a singular definition eludes even some professionals. Annuities are contractual investments between an insurer and an investor where the investor is a) given certain guarantees by the insurer such as the rate of return, terms of investment, any costs, and certain benefits, b) receives specific tax treatments such as tax deferred growth on earnings and taxation of earnings as ordinary income once realized, and c) receives certain benefits in many states such as Homestead Act provisions, protections from creditors in some instances, etc.

A lot of that is technical language, and that’s because Annuities are incredibly technical investments compared to what some investors are used to. In real terms, and Annuity is a guarantee based investment that has some tax benefits, some tax drawbacks in certain cases, a few additional benefits like Death Benefits and guaranteed income, and are overall looking to shift the risk of obtaining consistent income from the investor to an Insurer who is in almost all cases better equipped to take on those risks.

A last note I’ll add is that Annuities come in Fixed, Income, and Variable varieties. Variable Annuities involve the investor taking on some investment risk and Fixed Annuities involve the Insurer taking anywhere from much to nearly all of the risk. Who is taking risks and who receives what guarantees defines the different categories when you look at the universe of Annuities from a high level view.

Muti Year Guarantee Annuities offer one interest rate for the entire investment term. This blog post could practically be just that one sentence because it is so fundamental to understanding MYGA’s and they are simple investments by nature.

The reason that this matters is most Fixed Annuities use much more complicated systems of crediting interest to your Annuity. MYGA’s just use one rate, and that makes them very similar to another investment product most folks can buy from their bank. For Regulatory reasons, I can’t actually name that product in context of discussing MYGA’s because MYGA’s are not backed by the FDIC and drawing too close a comparison is frankly misleading in that regard. The resemblance is there, though, as you’ll see further in a moment. The guarantees MYGA’s receive are solely backed by the credit of the Insurer itself.

Here’s what that really means in practice: you see a MYGA advertised as yielding 3.1% for a 3 year term, and you buy it. Every year, you’re credited 3.1%. MYGA’s typically compound every year, and do so without tax consequence, making them very favorable investments. So the 2nd year, your 3.1% credit is based not on your initial investment, but your initial investment plus last year’s 3.1%. This income is not distributed to you during the three years, which is the means MYGA’s use to create a tax deferred investment return. It stays in the MYGA contract. At the end of 3 years, you have a matured contract that has been credited the full amount. You now have a 30 day window to let it roll over into a new term, or you can do something else with it (hint: this is another feature very similar to that product I can’t name).

Now, when I say you can “do something else with it,” that “something else” is a little different than what you can do with other investments. There are special tax considerations with Annuities that put some interesting decisions on the table. In a way, you have a more strategically intriguing menu of options. You can make a tax free exchange to another Annuity product using a process called “1035 exchange” that may be familiar to those of you who roll over Real Estate investments without tax consequence. Taking your money out of a matured MYGA contract can be a taxable event if you want it to be (i.e. you’re going to take that money and spend it) or it can not be if you want to go out and buy another Annuity. It doesn’t have to be another MYGA that you end up moving your funds to.

I hesitate to call this the fine print because the costs of bailing on your MYGA investment before the term is over are typically very explicitly listed and in bold. If you want to take your money out during the investment term, the insurance company will charge you money because you have exposed them to additional costs and risks. Contrary to popular belief, this is not a profit-motive move by the Insurer. The insurer would rather that you keep your money in the investment for the full term, and they typically break even at best after imposing a charge on you for pulling money out.

MYGA’s have liquidity features that vary by contract. A typical liquidity feature would be that you can take out 10% of your contract value every year without penalty. You don’t make money on the money you take out, of course. Anything above 10% of the value you take out during a specific year would incur a charge on the MYGA’s published “Surrender Charge” schedule. This is highest in the first year and decays to zero at the end of the policy.

As an example, one that I’m looking at as I write this offers a 3 Year MYGA of 3% return with a Surrender Schedule of 9% the first year, 8% the second year, and 7% during the third year.

Surrender costs don’t apply to death benefits or annuitization of the contract. Annuitization is where you turn the contract into a guaranteed income stream rather than continue to have it invested.

There can also be very gnarly Market Value Adjustments with a Surrender Charge MYGA. These are not a benefit to the investor and are only there to protect the insurer from loss during early years of a contract. These negative impacts could be a blog post in themselves, but suffice to say you don’t want an MVA to happen and they are easy to avoid with due research.

This is an entirely hypothetical example, based on the MYGA contracts I regularly read:

The ACME MYGA offers a 5 year term, at the end of which it can be renewed or redeemed without penalty. The interest rate during the term will be an annually compounding 3.3%. You can make 10% withdrawals annually without penalty. The surrender penalty schedule on amounts over 10% are the following percent by year from issuance: 9%, 8%, 7%, 6%, 5%. No penalties applied for Death or Disability. There is a $20,000 minimum investment, and minimum withdrawals are $250 per withdrawal. Annuitization options include Lifetime income, Joint Life, or 10 year period certain. Investors have 30 days to renew or redeem their funds at the end of 5 years, after which a new term and Surrender schedule will apply.