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You Can Replace Bonds and Have Higher Income, Greater Safety

Published on: Mar 25 2022

Bonds have been harming portfolios more than helping them since early 2020, and that’s likely to continue for a while. Investors are looking for alternatives to their fixed-income holdings.

We started decreasing our holdings of traditional fixed-income investments in our Retirement Watch portfolios when the Fed began trying to end the extraor- dinary monetary policies it instituted during the financial crisis. As inflation took hold, we further reduced them. Rising interest rates cause bonds to lose value. High inflation means interest rates are going to rise both higher and longer than markets currently expect.

In addition, despite the increase in rates in 2022, interest rates still are well below historic averages and have a lot of room to rise. When rates are low and likely to increase, bonds don’t provide their traditional diversification benefits to portfolios.

Bonds are supposed to rise,or at least hold their value, when stocks are declining. That reduces portfolio volatility. In addition, bonds are supposed to earn interest income that partially offsets the decline in stocks and reduces portfolio losses in stock market downturns. Bonds aren’t providing those benefits now. They’re generating very little interest and losing value at the same time as stocks.

Fortunately, there are solid alternatives to bonds. One set of alternatives is for those who still are in the accumulation phase of life. The other alternatives are for those who are using bonds to fund retirement living expenses. In the accumulation phase, or for money that you have set aside in safe investments for at least a few more years to earn interest, consider a type of annuity known as a MYGA (multi-year guaranteed annuity). The value of its principal is guaranteed by the insurance company, and the MYGA will earn more interest than you can from other safe in- vestments, such as certificates of deposit (CDs) and money market funds. A MYGA basically is a CD inside an annuity.

When you buy the MYGA, you determine the length of its term and the insurance company tells you the yield that will be credited to the account each year. A MYGA pays a higher interest rate than bank CDs. The rates vary based on your state of residence, but recently you could lock in a guaranteed three-year rate of 2.5% or a five-year rate above 3%.

How can MYGAs pay higher yields than bank CDs?

Insurers sell life insurance and other long-term contracts. That allows insurance companies to invest differently than banks. Insurers invest for a longer term in diversified portfolios and earn higher returns than banks, allowing higher yields on MYGAs.

MYGAs are for terms of one year or longer. MYGAs can be owned in IRAs as well as non-IRA accounts. There are no additional fees in a MYGA. The interest rate paid on the MYGA is determined after the insurer figures its expenses as well as its profit goal. A MYGA is a tax-deferred annuity.

Unlike a CD, when you own the MYGA outside an IRA or other retirement plan the interest grows tax-deferred as long as it remains in the MYGA. It is only taxed when distributed to you. Also, when the term of the MYGA ends, if you don’t need the money yet you can transfer the expiring MYGA to a new MYGA in a nontaxable transaction. When you need income, you can roll over the expiring MYGA to an income annuity. An alternative to a MYGA is a fixed indexed annuity (FIA).

A FIA credits interest to your account based on the performance of a market index named in the FIA contract. The interest rate isn’t guaranteed. If the index does well, you’ll earn more from a FIA than a MYGA. But if the index declines, you’ll earn only the guaranteed minimum interest rate, which recently was 0% or close to it for most FIAs.

Those are the bond alternatives in the accumulation phase. For those who are using the interest and gains from bonds to pay retirement expenses, consider shifting the bonds into an income annuity, also known as a single premium immediate annuity (SPIA).

After you make a deposit with the insurer to buy the SPIA, the SPIA begins paying you regular income. In the stan- dard SPIA, the income is paid for as long as you live or, if you’re married, as long as at least one of the spouses is alive. You can pick other options, such as payment for a term of years.

One of the little-known but attractive effects of SPIAs is that retirees safely spend more during their lifetimes when they move part of their portfolios into SPIAs. The income payments from the SPIA are higher than most people will take from their portfolios, partly because the SPIA payments consist of both principal and income.

Also, the knowledge that the pay- ments will continue for life no matter how long you live and what happens in the markets or with interest rates gives people peace of mind and the confidence to spend more money now instead of saving it for later.

In the November 2021 Spotlight Series, I explained this effect in detail and cite the research behind it. The income payment you’ll receive from a SPIA depends on your age, the payment period you select, and the state where you reside.

When you won’t need the income for a few more years, you can shift money to a deferred income annuity (DIA), also known as a longevity annuity, instead of waiting to buy a SPIA. The income payments begin on a date you select at least two years in the future, and you’re told when you buy the DIA what the amount of your guaranteed future payments will be. Interest rates on MYGAs and income payments from SPIAs and DIAs vary considerably among insurers.

To maximize income and safety, you need shop around and work with an insurance agent who deals with a wide range of insurers instead of focusing on only a small number. That’s why I recommend using the website of Stan Haithcock, also known as Stan the Annuity Man.

At www., there are calculators that let you shop the whole market and find the annuity that’s best for you. You won’t receive any follow-up telephone calls from insurance agents after you use the calculators, even if you don’t buy an annuity. Another good resource, especially if you’re interested in FIAs, is Todd Phillips of Phillips Financial Services (888-892- 1102).

I’ve known Todd for years. He’ll learn about your situation and goals and then research the market of FIAs and other annuities before deciding what to recommend to you.



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