Retirement Income Blog

 
Thanks to the FDIC, millions of Americans are able to sleep peacefully at night, knowing that their savings are protected by government-backed insurance. Since the thirties, certificates of deposit have become synonymous with safety of principal. Bank customers who shop for CDs concern themselves only with the rates and terms that are available as CD investing is riskless within the insured amounts.  When financial planning for retirement, CD investing can be a cornerstone of those plans.

Unfortunately, the safety that comes with FDIC insurance comes with a price. Will Rogers once said, “It’s not the return on my money that concerns me, it’s the return of my money.” This famous saying exemplifies the attitude of many bank customers. While CD investments are among the safest types of investments available, their rate of return is correspondingly low. If interest rates are around 4%, then that is about what you can expect a short term CD to pay. While longer term and jumbo CDs can pay slightly more, it is very difficult to see much real growth (i.e. after inflation and taxes) from them over time. CD investing is easy and safe, but doesn’t often pay very well.

However, there is another option available for those seeking higher rates on their guaranteed CD investments. Unbeknownst to many CD buyers, many brokerage and investment firms offer CDs. While these brokered CDs do differ from their cousins in the banking system in some respects, they are still FDIC insured up to $250,000 per owner or beneficiary (through 12/31/2009). CD investing is easy through a brokerage because you can choose from among many banks or diversity amongst banks all on one statement. Furthermore, brokered CDs generally pay a higher rate than bank CDs, and they often contain other features, such as put or call options that allow either the buyer or the issuer to redeem the certificate prematurely without penalty. (Use the retirement calculator to see the impact of an additional 1% interest over time). For example, a brokered CD with a 20-year maturity could be “puttable”, after five years, if the buyer so desires. That means that five years from now, if rates have gone up and the buyer wishes to move the money in this CD to another one, then he or she can put the CD back to the issuing bank for return of their original principal.  But read the fine print.  The put feature is often subject to available of funds and is not a guaranteed feature.

Call features give the issuing bank a similar privilege as prior to maturity, the issuing bank can return the investors principal. CD investing can also get more complex and profitable if you want to take advantage of another’s misfortune as you can buy brokered CDs on the secondary market from a person who needs the money early (and will likely need to sell to you at a discount). Note that the FDIC guarantee will only apply for investors that either hold their certificates to maturity or redeem them in a put or call transaction so if you buy a CD on the secondary market, check the quality of the issuing bank. If the certificate is sold prematurely in the secondary market, then the owner may receive more or less than his original investment, depending on market conditions. But those who hold their CDs to maturity can enjoy higher rates of income.  These long term CDs should be considered illiquid investments even though there may be liquidity possibilities.

Note that brokered CDs usually are of a longer term or have features not typical of the CD from your neighborhood bank.  Brokered CD investing may not be right for you.  Just understand all of the features to decide.

Post provided by Javelin Marketing

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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:
Some retirement planner 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 search 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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