Individual Bonds vs. MYGA's

[MercyMe]

I've been following Freedom56's We are entering a "Golden Period" for fixed income investing thread since it started and have become thoroughly interested in learning how to evaluate individual bonds. I spent about 20 hours reading everything I could and well I just don't think I'll ever fully get it.

As I was confessing to a friend that I felt so stupid about this, he asked me a question that I thought the forum might be able to comment on.

My spouse and I are currently in the top tax bracket, but when we retire next year (at age 53-ish) we will be spending down from our taxable accounts for many years and thus our tax bracket will probably be very low for a good while - even with some Roth conversions in there. One strategy we have now for our fixed income investments is to use MYGA's. An "A" rate insurer is paying about 4.4% right now for a 5-year product. What we like about these annuities is that the tax is not due on these until they mature. For us, they will mature when we are in a much lower tax bracket.

Considering that a reasonably safe bond now is paying around 35 basis points more than a MYGA, and in light of the tax timing, doesn't it even make sense for us to invest in individual bonds?

 

[jazz4cash]

I spent about 20 hours reading everything I could and well I just don't think I'll ever fully get it.

Considering that a reasonably safe bond now is paying around 35 basis points more than a MYGA, and in light of the tax timing, doesn't it even make sense for us to invest in individual bonds?

Twenty hours of research is way too soon to conclude you’ll never get it.

I’d say use both bonds and MYGA’s to build a ladder. MYGAs are very easy. Bonds are more complicated (and riskier) but you can pick the maturity timing and find bargains if you are diligent. MYGAs tend to be static. Bonds are dynamic. You must’ve seen the 3 yr 4.5% note discussed in the thread you mentioned.

 

[pb4uski]

... Considering that a reasonably safe bond now is paying around 35 basis points more than a MYGA, and in light of the tax timing, doesn't it even make sense for us to invest in individual bonds?

I think individual municipal bonds would be better than MYGAs in your situation... MYGAs are only tax-deferred, but individual municipal bonds are tax-free.

 

[Dash man]

If you plan on withdrawing interest from your MYGA, it will be taxable in that year.

 

[ShokWaveRider]

I think individual municipal bonds would be better than MYGAs in your situation... MYGAs are only tax-deferred, but individual municipal bonds are tax-free.

Are their yields comparable, and can they be cashed in without penalties after 3, 4 or 5 years?

 

[pb4uski]

While I haven't researched it, I suspect that since the OP is in the highest tax bracket (37%) that the after-tax yields are probably better. The muni would only need to be 2.9% to be better than 4.5% taxable.... even less if the muni was from the OPs state.

There are no penalties and they can be sold at any time. There is interest rate risk but that can be mitigated by selecting the right maturities.

So the OP could create a ladder that aligns with their cash flow needs to mitigate the interest rate risk.

njhowie is our resident guru on munis and there is a thread on them here https://www.early-retirement.org/forums/f44/muni-bond-and-muni-bond-fund-discussion-104000-21.html

I'm not saying that munis are necessarily the answer, but they are worth a hard look for folks in the highest tax bracket.

 

[COcheesehead]

5 year investment grade munis are around 3%. If you buy your state specific, they will also be state tax free. They as liquid as the day is long, but will rise and fall with mark to market pricing.
I fund, actually overfund, all of our retirement cashflow needs with a muni bond ladder and would never buy a structured product to replace it.
If you are willing to go a bit longer in duration, munis can pay into the 4%+ range.

 

[Freedom56]

Corporate bonds yields are much higher in the secondary market if you are willing to assume slightly more risk. Looking at the big picture is buying a high yield two year note with a YTM of 6.5% from an issuer that that has an 11 times coverage of interest expense really that risky? There is far more transparency in the financials of a publicly traded Fortune 500 company than many insurers that sell annuities. The ratings of insurance companies are dubious at best. Consider that AM Best rated AmTrust at A+ and even after all the fraud investigations and settlement with the SEC, they only lowered the rating to A-. AmTrust caused a lot of misery for its investors of the debt they issued after the common stock and all their preferred stock were delisted. I'll buy short term BB to BB+ corporate debt of any well managed telecom or technology company at 7-8% yields before I invest in an annuity of a so called "A" rated insurance company. An "A" rated issuer such as the Bank of Montreal or any of the other major Canadian chartered banks is orders of magnitude safer than the average A rated insurance company. So we are not comparing apples to apples.

 

[pb4uski]

A.M. Best ratings are related to the insurers capacity to pay claims and other policy obligations and are not related to their bond ratings. The major rating agencies (S&P, Moody's and Fitch) issue separate ratings for insurers bonds and claims paying ability.

I would ignore A.M. Best when looking at bonds or preferred stock... since they are junior to policy obligations an insurer's bonds and preferreds would be rated lower. Also, A.M. Best is rating the insurer and bonds and preferreds are often issued by the insurer's holding company parent.

 

[Freedom56]

A.M. Best ratings are related to the insurers capacity to pay claims and other policy obligations and are not related to their bond ratings. The major rating agencies (S&P, Moody's and Fitch) issue separate ratings for insurers bonds and claims paying ability.

I would ignore A.M. Best when looking at bonds or preferred stock... since they are junior to policy obligations an insurer's bonds and preferreds would be rated lower. Also, A.M. Best is rating the insurer and bonds and preferreds are often issued by the insurer's holding company parent.

Their debt was not rated. This was an example of how an A+ rating of an insurance company does not mean that they are a financially sound company. There are far too many insurance companies in this country. Those that are not publicly traded do not have the same financial disclosure and audit requirements. Many are outright scams. The point I was attempting to make is that an A rated insurance company does not make it safe. It is nowhere near as safe as an "A" rated Fortune 500 company. There is a complete lack of transparency in the insurance industry. If you don't want regular coupon payments, then buy a zero coupon bond or a CD that pays at maturity.

 

[ShokWaveRider]

Their debt was not rated. This was an example of how an A+ rating of an insurance company does not mean that they are a financially sound company. There are far too many insurance companies in this country. Those that are not publicly traded do not have the same financial disclosure and audit requirements. Many are outright scams. The point I was attempting to make is that an A rated insurance company does not make it safe. It is nowhere near as safe as an "A" rated Fortune 500 company. There is a complete lack of transparency in the insurance industry. If you don't want regular coupon payments, then buy a zero coupon bond or a CD that pays at maturity.

Remain a skeptic, that is great, do as you think what is right and comfortable for you. Nothing wrong with that.

Here is an example of a random insurance company's assets. Scroll down a little.

https://www.immediateannuities.com/...ghthouse-fixed-rate-annuity-mva-5-review.html

And another:

https://investor.brighthousefinancial.com/financial-ratings

 

[jazz4cash]

This is a great discussion. I have long maintained that insurance company ratings get conflated with debt rating without full understanding the details. My understanding is that a corporation may issue debt with various ratings depending on the details of the bond but an insurer is rated only on it’s estimated ability to pay claims (which should include annuity obligations) and regulated at the state level.
I am in favor of owning all flavors of these fixed income instruments but the munis are the best. That zero coupon CD I bought from JP Morgan is not looking too good right now

 

[Freedom56]

Remain a skeptic, that is great, do as you think what is right and comfortable for you. Nothing wrong with that.

Here is an example of a random insurance company's assets. Scroll down a little.

https://www.immediateannuities.com/...ghthouse-fixed-rate-annuity-mva-5-review.html

And another:

https://investor.brighthousefinancial.com/financial-ratings

Why buy the annuities from Brighthouse Financial when you can earn over 6% from their BBB+ rated notes? The bonds/notes offer better protection and better yields. Again those A+ from AM Best are dubious at best.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C903331&symbol=BHF4987731

 

[Freedom56]

This is a great discussion. I have long maintained that insurance company ratings get conflated with debt rating without full understanding the details. My understanding is that a corporation may issue debt with various ratings depending on the details of the bond but an insurer is rated only on it’s estimated ability to pay claims (which should include annuity obligations) and regulated at the state level.
I am in favor of owning all flavors of these fixed income instruments but the munis are the best. That zero coupon CD I bought from JP Morgan is not looking too good right now

Insurance companies can also pay claims with funds from annuity investors. The ability to pay claims means nothing.

 

[pb4uski]

Why buy the annuities from Brighthouse Financial when you can earn over 6% from their BBB+ rated notes? The bonds offer better protection and better yields. Again those A+ from AM Best are dubious at best.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C903
331&symbol=BHF4987731

Why don't you just ignore the AM Best ratings?... I would as they don't apply to bonds even to begin with.

While the bonds provide better yields they do NOT provide better protection... in the unlikely event that Brighthouse went into receivership, policy obligations would come before any bonds.

 

[pb4uski]

Insurance companies can also pay claims with funds from annuity investors. The ability to pay claims means nothing.

I dunno... claims paying ability mean a lot to life insurance and annuity policyholders... if you meant that the ability to pay claims means nothing to bondholders, I agree.

 

[Freedom56]

Why don't you just ignore the AM Best ratings?... I would as they don't apply to bonds even to begin with.

The OP was confusing AM Best ratings for annuities with corporate bond rantings. They are not the same.

Secured bond holders come first followed by unsecured bond holders. As for the rest...

https://www.nytimes.com/2008/11/15/business/yourmoney/15money.html

 

[ShokWaveRider]

I confess, I was an annuity skeptic for the longest time, and uneducated one. Once I looked into them, I realized it was the brokers that were the liars and the cheats, maximizing their fees by recommending the highest fee annuities and not the less profitable (for them) FIAs and MYGAs. I am still totally against those unpredictable annuities pitched by most brokers at their lunch and dinner parties.

Compare it to the Medicare Advantage vs the more reliable supplement plans. They get paid a lot more when you get an Advantage plan, vs a Plan N or Plan G. Same rules apply.

 

[jazz4cash]

I confess, I was an annuity skeptic for the longest time, and uneducated one. Once I looked into them, I realized it was the brokers that were the liars and the cheats, maximizing their fees by recommending the highest fee annuities and not the less profitable (for them) FIAs and MYGAs..

The bad annuities/sellers seem to have tainted the entire industry. I assume even the bad annuities might be appropriate for specific situations but they have been oversold and misapplied due to greed. I still hear these products pitched on the radio every Sunday and when the market is volatile these pitchmen thrive on fear.

 

[Freedom56]

I confess, I was an annuity skeptic for the longest time, and uneducated one. Once I looked into them, I realized it was the brokers that were the liars and the cheats, maximizing their fees by recommending the highest fee annuities and not the less profitable (for them) FIAs and MYGAs. I am still totally against those unpredictable annuities pitched by most brokers at their lunch and dinner parties.

Compare it to the Medicare Advantage vs the more reliable supplement plans. They get paid a lot more when you get an Advantage plan, vs a Plan N or Plan G. Same rules apply.

It's a free country. You can invest however you want. This is the golden period for fixed income investors and savers. Enjoy it while you can.

 

[pb4uski]

The OP was confusing AM Best ratings for annuities with corporate bond rantings. They are not the same.

Secured bond holders come first followed by unsecured bond holders. As for the rest...

https://www.nytimes.com/2008/11/15/business/yourmoney/15money.html

But you need to consider corporate structure. Usually bonds are issued by the holding company which relies on dividend distributions from the insurance subs to service the bonds. There are regulatory restrictions on dividend distributions from the insurance sub to the holding company. If the insurer were troubled enough that its financial strength and ability to pay claims was in question, the regulators would disallow dividend distributions from the insurance sub to the holding company. So as a practical matter, the policyowners come before the bond holders.

 

[aja8888]

One thing about insurance products:

Mutual Benefit Life was holding my 401K in the early 1990's.

Remember them?

 

[Freedom56]

One thing about insurance products:

Mutual Benefit Life was holding my 401K in the early 1990's.

Remember them?

Soured real estate deals...Receivership...Liquidation of assets.. policy holders lost the cash value of their policies...

 

[aja8888]

Soured real estate deals...Receivership...Liquidation of assets.. policy holders lost the cash value of their policies...

It took me years to get my 401K back with very little earnings over the period it was "gone". It was so convoluted I'm not sure to this day if I even got all I put in.

 

[pb4uski]

Soured real estate deals...Receivership...Liquidation of assets.. policy holders lost the cash value of their policies...

Yes, MBL was one of the nasty ones. I don't think that policyholders lost money... they lost access to cash out for a while so there would not be a run on the bank so the real estate portfolio could be worked out orderly rather than a fire sale but my understanding is that policyholders did, eventually, receive what they were due, including principal and any minmum guaranteed benefits and more.

I remember serving on a task force where a number of solid insurers banded together to reinsure some of their separate account business to help protect policyholders if some of the real estate wasn't able to be worked out. I left my employer before it was done, but I think MBL was able to work it out without the reinsurance ever coming into play.

Eventually the business was placed with other healthy insurers.

The MBL and Executive Life receiverships resulted in significant reforms to restrict investment concentrations and regulatory surveilance so that there have not been any significant rehabiitations since (there have been some smaller ones).