Why CD Annuities Are Turning Heads

Many of the buyers are older boomers who are growing increasingly concerned about their nest eggs. According to a study released this month by AXA Equitable, New York, 51% of older affluent individuals polled (those aged 45-plus with household incomes of $100,000 or greater) rank securing a guaranteed fixed rate of return as a "financial concern." This compares with 43% for the young affluent, or those between the ages of 25 and 45.

While demand is rising for CD annuities, the products are, paradoxically, getting harder to buy–at least through certain carriers. Thomas Kestler, a certified financial planner and chairman of Kestler Financial Group Leesberg, Va., says the cost of the product to the insurer typically ranges between 6% and 8% of the invested principal. Thus, on a $100,000 annuity, the "hit" to the insurer's surplus (or reserves) would total between $6,000 and $8,000.

To make it worth their while to offer multi-year guarantees, says Kestler, some carriers are substantially raising minimum investment requirements. Still others are restricting sales by terminating non-profitable relationships with partnering insurance marketing organizations or by capping the amount of business they will accept from IMOs.

"Whereas CD annuities are getting a lot of consumer interest, the carriers we interface with are slowing the volume of sales," says Kestler. "This is the first time since I've been in the business that we as an industry can generate more sales than the carriers will actually accept."

But even when available to purchase, a CD annuity should play but a limited role in a client's portfolio, say experts. Kestler says the product is well-suited to short-term investing–5 years or less–but should be avoided for the long-term.

The reason: interest-rate risk. Should interest rates rise in the near future, as Kestler expects they will due to the growing national debt (which, in theory, can raise rates by displacing or "crowding out" funds for private capital), then investors who are stuck with, say, a fixed rate in a 10-year CD annuity will be denied the additional interest they would otherwise have earned on a vehicle offering a fluctuating rate.

Pulling out of a fixed annuity prematurely could also be costly because doing so would incur an early surrender charge. Also, should rates on Treasury notes rise between the annuity's purchase and surrender dates, the customer would incur a negative market value adjustment as well. Thus, Gahler warns, clients need to think carefully about their financial objectives and time horizon before investing in the product.

Sources say a CD annuity often does make sense when integrated into annuity laddering strategy. Assuming 3 annuities or "income buckets," the first and last of the buckets might comprise, respectively, a single premium immediate annuity and (for long-term investing) a deferred variable annuity. The second bucket might consist of 3- to 5-year CD annuity.

"We use this strategy quite a lot, especially for clients who come to us with income needs," says Kestler. "But we don't necessarily counsel buying a living benefit rider for the last of the buckets–the variable annuity.

"The two things clients can control with investments are time and allocation," he adds. "Historically, time is what gives you performance. So the longer is the time frame, the less valuable that rider becomes."