Prayers are seldom answered in newspapers. When it happens, we notice. That’s why many readers have asked about the high FDIC-insured yields that are advertised in newspapers across the country.
Recent ads offered yields ranging from 6 percent (annualized) for 3 months to 4.75 percent for 6 months. Rates like this haven’t been seen for years.
Here’s a broad sample of actual market rates in the same week.
- On www.bankrate.com the highest yield in the country on a 3-month CD was 0.90 percent. The national average was only 0.28 percent. The top yield on 6-month CDs was 1.2 percent. The national average was 0.79 percent.
- On www.banxquote.com the highest yield on a 3-month CD was 0.50 percent, well over their national average of 0.19 percent. The highest offer was the same on a 6-month CD, but their national average rose to 0.24 percent.
- On the Charles Schwab website, brokered CDs in smaller denominations were offering 0.15 percent for 3-months and 0.20 for 6-months.
- On the Fidelity website, brokered CDs in smaller denominations were offering 0.20 percent for both 3 months and 6 months.
- The U.S. Treasury, according to Bloomberg, offered even less—0.08 percent for 3-month T-bills and 0.17 percent for 6-month T-bills.
So unless you do a lot of shopping, you’re going to get less than 0.25 percent on a 3 or 6-month CD. The very best you could do would be 1.2 percent for six months.
Yet a newspaper ad offers 5 times as much— 6 percent. How can this be?
Part of the answer is in the small print: “Yield may include bonus.” The bonus is paid by the sales company brokering the CD.
When I visited one office in the Austin area, the salesperson scribbled on a piece of paper and handed it to me as an example. It showed 2.75 percent from the bank plus 2.00 percent from his company, a total of 4.75 percent. He called it a “subsidy” from his company.
When I asked, “What’s in it for you?” he assured me that he was paid, but would not say how.
So let’s do some math. If you buy a 6-month CD with an annual percentage yield (APY) of 4.75 percent and commit $25,000, you’ll earn $594 in interest, not including any compounding. The same money in the highest yielding bank CD in the country earned 1.2 percent. That means the bank would have paid $150 in interest.
This leaves $444 to come out of someone’s pocket. Some of it may come as a commission to the broker from the bank. But you can be sure the bank isn’t paying $444 every six months for a $25,000 deposit. That would cost $888 a year in commissions and $300 in interest, a total of $1,188. And that’s assuming the salesperson works for nothing and gets his office for free. Not likely.
Richard M. Schwartz, an FDIC attorney, had this comment about these offers a year ago, "An offer of a very high interest rate may be a lure to promote the sale of non-insured products. Some non-bank companies are using the FDIC logo and good name to draw customers in the door for a bank CD, but sooner or later, they're going to try to lock them into a long-term investment that may not be in the customer's best interest."
Danny Fisher is more direct. “There is no free lunch. If anyone is saying they are paying 5 percent, there is a snake in the woodpile.” Known as Mr. Annuity in Dallas, he has kept a database of more than 700 CD-like annuities for decades. He regularly combs it for the best offers. The highest yield on his current Top 10 list is 3.85 percent, guaranteed for 7 years. (The list is available at www.mrannuity.com .) Note that it is well below the yields offered in newspaper ads.
The advertised high yields are promotions to attract people with ready cash. The “subsidy” means that sooner or later you’ll be pitched a high-commission insurance product.
While the salesman did not offer an insurance product on my first visit, when he called again he mentioned that he had an insurance product that would pay 8 percent simple interest. When I came for a second visit he had a printout offering the Allianz MasterDex X Annuity, an equity index annuity that has been the subject of a class action suit and that offers one of the highest commissions in the industry (see sidebar).
How an 8 percent guaranteed simple interest return is a lot less than it seems.
Before I left his office the salesman assured me that I couldn’t do better than the product he offered.
On its face, it seems like a great opportunity. My investment of $40,000 today, at age 69, would get an immediate “bonus” of 10 percent, or $4,000. In addition, it would earn 8 percent simple interest each year. If I let it accumulate for 5 years its value would be $60,000. Those are the numbers in the insurance illustration I was given.
So what’s the catch?
You can’t get that $60,000 in a single check. You must take a series of income payments that turn out to be worth far less. Beginning at age 74, and based on a single life with no beneficiary, the initial payment would be 4.5 percent of $60,000, or $2,700 a year. In later years the income could rise with adjustments in the equity index, but it would never fall.
Query: Is that $60,000 really worth $60,000?
You can decide by examining this alternative. According to www.immediateannuities.com, a 69 year old Texas man can have an immediate lifetime income of $282 a month, or $3,384 a year, from a $40,000 life annuity. This means I could collect that income for 5 years and accumulate $16,920 before I would get a dime out of the product I was offered.
At the end of the 5th year, the alternative life annuity would still be paying $3,384 a year. That’s $684 a year more than the income I would be getting from the Allianz product I was offered. I would also have the $16,920 that had accumulated over the 5-year waiting period.
So the $40,000 life annuity is ahead of the high commission product by $684 a year and $16,920. (Note: you’ll have to pay taxes on a portion of the life annuity income, but the monthly payments may also earn a small amount of interest during the 5 years.)
Now let’s take another step to make it an apples-to apples-comparison. Suppose I buy a second life annuity with the accumulated $16,920 when I’m 74? That would add another $139 a month to my income, or $1,668 a year. My total income from the $40,000 investment would now be $5,052 a year.
That’s nearly twice the $2,700 a year from the equity index product I was offered.
So you tell me. Would you rather have $5,052 a year fixed for life from a $40,000 life annuity investment… or $2,700 a year from an equity index annuity that might rise with the stock market? As I have shown in other columns on living benefits products, the nominal values in your account have little meaning. What counts is the value of the lifetime income you may receive.
Sadly, most sales are to unsophisticated individuals. They trust the assurances of the salesman that his offer is the best thing around.