Retirement Income Blog

Want to play the stock market without risk?  FDIC insurance will help you do that.

The FDIC insures the “index-linked” CDs offered by some banks. These CDs pay interest based upon the overall performance of a stock market index, and your principal deposit is FDIC insured up to current limits (generally $100,000 and $250,000 for retirement accounts). Here’s an example of how one of these CDs works. Please note, however, that the various features of these CDs vary from bank to bank (e.g., maturity, interest rate determination, withdrawal penalties).

Here’s a hypothetical example. You make a deposit, say $10,000. The FDIC insured CD has a 3.75 year maturity, non-callable. At the end of 3.75 years, you would receive your deposit back plus interest based upon the movement of a pre-selected stock market index, such as the S&P 500.(1) Let’s assume that the S&P 500 index increases 3% per calendar quarter over the next 3.75 years. In this hypothetical example, you would receive $12,271.  That’s equal to a 5.6% annual return.  Had you invested in the S&P 500 index, you would have received 12% annually, plus dividends. But with the CD, even if the market drops, you still have your original $10,000 FDIC insured.

The attractive feature of such CDs is that you could earn a higher amount of interest than the fixed rates offered by most banks. However, you could earn zero if the stock market falls during the term of the CD. Your full deposit is always returned to you at maturity no matter what occurs in the stock market due to the FDIC insurance. Index-linked CDs are subject to early withdrawal penalties, and an investor is not guaranteed to receive 100% of his or her principal investment if funds are withdrawn prior to maturity. Also, an investor’s right of early withdrawal can be limited to certain dates.

Note that some varieties have a “cap” limiting the gain. For example, a 100% cap would mean that a $10,000 CD would not provide more than $20,000 no matter how large the gain in the stock market index. Others may have a call feature allowing the issuing bank to redeem the CD before maturity at pre-stated prices.
Yet others may have a “participation rate” where you partially participate in the index gain. For example, if the stock index rises by 100% and your participation rate is 50%, you enjoy only half of the market gain. All of these features are included in the descriptive materials. So read and understand them carefully before you invest.  If consfused, take the description ot an accountant or financial planner for interpretation.

If you think that the stock market performs well over the long term, index-linked CDs could interest you. It’s an opportunity to participate in potential market gains and to protect your principal from market losses. But some people may still opt for the traditional CD with its fixed payment of 3 to 5 % (Bankrate.com’s national average rate for five year CD was 3.39% as of 2/04/08).

If today’s CD rates leave you yearning for a higher return with safety, FDIC insured index-linked CDs could be for you.

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Callable CDs

“Callable CDs” are a variety of CDs that often pay more than regular (non-callable) CDs. These CDs come with Federal Deposit Insurance Corporation insurance (FDIC), full principal repayment at maturity and above-average yields.  These insured CDs appeal to safety-conscious retirees looking for income.

Although FDIC insured, that does not mean they are not without risk. These FDIC insured CDs have features you must understand. Before you jump at the rate offered by some ad in the Sunday newspaper, here’s what you need to know about the features offered:

High Rate
The higher rate could be temporary. Some callable CDs are callable after a year or two, which means you can get paid off and your high rate stops. Although your principal may still be insured by the FDIC, you may be required to find another place to invest your money which could subject your investment to interest rate risk (i.e having to accept a lower rate than you were earning). Although the bank could have the option to pay you back after one or two years, you do not have the same flexibility.  If you want to terminate your deposit, it could cost you as described below.

Banks offer FDIC insured callable CDs to shift interest rate risk to the depositor. Because the depositor is taking on this interest rate risk, a callable CD will have a higher yield than the same maturity CD without a call provision. The additional yield is partial compensation for the depositor accepting the interest rate risk. Callable CDs typically have terms of 10 or 20 years. Therefore, these CDs are typically suitable for someone who does not need liquidity and wants higher returns than a non-callable CD and the safety afforded by the FDIC protection. Consider that earning more on your money could reduce the need for you to tap into your principal investments. If you buy such higher-paying CDs, it might be wise to keep other money for liquidity available in a money market account or bank account.

Although money market accounts are typically considered to be safer than many equity investments, money-market shares are redeemable at net asset value, which may be more or less than original cost. An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in such a fund.

These callable CDs are suitable for:
• People who want to protect their “core” principal that they never want to spend
• People who want to leave money for heirs
• People who need to safely maximize income
• People who have adequate liquid resources

Take these precautions:
Someone may tell you that you can sell these CDs at any time. It is true that most banks will buy back the CD from you but it could be at a steep discount. The ONLY way to be sure to get all of our pricnciapl back is to hold the CD to maturity (could be 10+ years) or until called by the bank. With respect to principal repayment, the bank’s obligation is to pay you back at maturity.

You may be told that if you pass away before the CD matures, your heirs can “put” the CD back to the bank and get the principal. This offer however is dependent upon the bank having enough funds in the “put” pool. Your heirs will have priority but could wait to see cash, months if not years.

To find callabale CDs at 6%, just do a Google serach on “callable CDs” and you will encounter many offerings.  This site does not require any login http://www.bergencapital.com/clientservices/inventory/cd_inventory_new_issue.htm

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The attraction of a certificate of deposit (CD) is its higher interest rate over your bank’s regular savings account rate. Also, federal deposit insurance secures it up to $100,000 per institution ($250,000 if an IRA). CD returns today offer new options that seniors who seek short term secure investments should be aware of.  CDs can play an important part of the conservative porion of your retirement investing portfolio.

Traditionally when you purchase a CD, you invest a fixed sum of money for a fixed term – six months, one year, five years, or more for a fixed CD return. The bank pays you a fixed interest rate and you receive your investment back when the CD matures. If you redeem it earlier, you pay an “early withdrawal” penalty or forfeit a portion of the interest. So you need to plan your cash needs accordingly to not be penalized.

Today, CDs offer more options . You can choose among variable rate CDs and long-term and callable CDs. You can even buy them through your broker. But not understanding each type’s exact features can leave you with an investment you didn’t mean to buy.
 
Some long-term, high-yield CDs have “call” features. The issuing bank may call (i.e. terminate) a CD after only one year or some other fixed period of time, perhaps because interest rates are falling. You’ll receive your full investment back plus accrued interest, but you lose out on your high interest payments in the future.

On the other hand, if you’ve invested in a long-term CD and interest rates subsequently rise, you’ll be locked in at the lower rate unless of course you pay the early withdrawal penalty.

Before you consider purchasing a CD, make sure you fully understand its terms. Know its maturity date and don’t confuse it with the call date.

As an example, don’t assume that a “federally insured one-year non-callable” CD matures in one year. It doesn’t! These words mean the bank cannot redeem the CD during the first year, but have nothing to do with the CD’s maturity date. A “one-year non-callable” CD may still have a maturity date 15 or 20 years in the future! In other words, when you see a high CD return make sure you understand why the return is so high.

Investors have accidentally bought 10 year CDs when they only wanted to tie up their money for 1 year. If you have any doubt about your CD’s maturity date, ASK. Fully understand the CD’s call features confirm when it matures.

Always remember that you’re insured only up to $100,000 per institution under federal deposit insurance rules. So, if you buy CDs through a broker, make sure that your CDs are held among institutions so that you don’t exceed $100,000 at any one or use different titling to increase your FDIC coverage.

How much should you invest in CDs.  That depends on the results from your retirement planning calculators and you asset allocation among insured investments and those with greater risk yet higher return.

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Are you disturbed by the rates on CD savings at your bank? Not enough to satisfy your retirement income plan goals?

Many banks are FDIC insured, just like your local bank. Shop around for the best Certificates of Deposit. Check out other banks and saving institutions in your neighborhood, and in other states. Their rates could be higher than what you can get locally. In fact, the highest rates offered by some banks could be 40% higher than national averages… sometimes more.

How do you shop for a competitive rate? You could spend hours searching the Internet and maybe find a few. Alternatively, many financial planners and retirement consultants can do the shopping for you.  You don’t actually pay a fee for this service.  The CD you purchase for $100,000 will be sold to your retirement consultant for $99,000 so he earns 1% for shopping and assisting you.

Here are various types of CD savings accounts available, beyond what your local bank offers:

Callable CDs

“Callable CDs” are a variety of CD savings accounts that often pay more than regular (non-callable) CDs. The Federal Deposit Insurance Corporation insurance, full principal repayment at maturity and above-average yields appeal to safety-conscious retirees looking for income.  Although FDIC insured, they have features you must understand so read the brochure completely.  If you don’t, you could be stuck in a CD for 15 years.

Banks offer callable CDs to shift interest-rate risk to the depositor. Because the depositor is taking on this interest-rate risk, a callable CD savings account will have a higher yield than the same maturity CD without a call provision. The additional yield is partial compensation for the depositor accepting the interest-rate risk. They may have terms of 10 or 20 years. Therefore, these CDs are typically suitable for someone who does not need liquidity and wants higher returns than a non-callable CD and the safety afforded by the FDIC protection.

Index-Linked CDs

These CD savings pay interest based upon the overall performance of a stock market index, and your principal deposit is FDIC insured up to current limits. Here’s an example of how one of these CD savings accounts work. Please note, however, that the various features of these CDs vary from company to company (e.g., maturity, interest rate determination, withdrawal penalties).

Here’s a hypothetical example. You make a deposit, say $10,000. The CD has a 3.75 year maturity, non-callable. At the end of 3.75 years, you would receive your deposit back plus interest based upon the movement of a pre-selected stock market index, such as the S&P 500.² Let’s assume that the index increased 3% per calendar quarter over the next 3.75 years. In this hypothetical example, you would receive $12,271 (interest rates are subject to change and your actual results will vary). Please note that this example is used for illustration purposes and is not a prediction of future market performance.

FDIC Insurance - Do You Really Understand It?

Most people realize that their CD savings are insured up to $100,000 per person, per institution. To ensure that all your accounts are fully insured, you could just spread your money among different banks. However, you can also keep accounts at the same banks and get several hundred thousands of dollars of insurance if your accounts are organized correctly.

One strategy is to use trusts or “pay-on-death” designations. Accounts that have named beneficiaries are insured $100,000 per named beneficiary. Here’s an example of how two parents and one child can insure $1.2 million of deposits using the correct designations on accounts:

How a husband, wife and one child
may have insured amounts totaling $1,200,000

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