How (and Where) to Invest in Structured CDs

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(Note: This is part 3 of a series of posts about the benefits and costs of Structured CDs.  Link to Part 1 (Structured CD Risks) / Link to Part 2 (Structured CD Benefits).  At the time of this article, I own an S&P Index-linked Structured CD in a retirement account).

Here’s How (and Where) to use Structured CDs.

DON’T use them in a taxable account – your returns or ‘payback’ at the end of the contract is taxed as ordinary income.

DO buy them in an IRA or Roth IRA account. Your gains are tax-deferred.

DON’T buy anything you can’t understand after spending 5 minutes reading the prospectus.  There are some very complex structured products out there! (Note: I own a point-a-to-point-b S&P index-linked CD. These are readily available through Fidelity in $1,000-sized  increments).

DON’T buy a Structured Product that tracks an index you’ve never heard of, like ‘BRIC Currency Baskets’,  or ‘Communicable Diseases Index’, etc.  Here is a list of some of the wackier products available.

DO use Structured CD’s as a substitute for a Bond Ladder when short-term Bond Rates are at or near zero (like now).  Rather than buying individual bonds or CDs, Buy a 5-year index-linked CD once a year, rolling them over until ‘real’ CDs offer historically attractive rates of return.

Think now is a good time to buy a ‘diversified’ bond index fund?  Think again.  With current interest rates near zero, bond prices will tank if (and when) interest rates rise.  There’s likely nothing but downside to investing in any bond index with a weighted maturity longer than an intermediate term bond fund (3-7 yrs).  You could end up purchasing what you think is a ‘safe’ bond investment in the AGG (The Artist Formerly Known as the Lehman Aggregate Bond Index), and it could crash just like the stock market (H/T to Dr. Wade Pfau).  And note that the venerable bond trading house who created the aggregate bond market index (AGG)- Lehman Brothers- Was wiped from the face of the earth by bankruptcy in 2008.  So, If bond funds all are so safe, ask yourself how one of the biggest bond trading houses went broke?

DO consider using Structured CDs if you are doing Roth Conversions from Traditional IRAs. In this case, if you buy a 5-year Structured CD, you are guaranteed to receive 100% of your Roth conversion amount at the end of the Roth conversion holding period (5 years).   You could use this tactic as a way to access IRA funds prior to age 59 1/2 without paying tax penalties (using 5-year waiting periods for each Roth Conversion event instead).   For more on this, see the ‘Roth Escape Hatch Loophole‘ post (See ‘Strategy #2’) on Mr. Money Mustache’s blog.  Since your Roth Conversion Basis (the amount invested in a Structured CD) is guaranteed, if the linked index rises you can earn some ‘gravy’ 5 years down the road when the Roth Conversion Amount is available tax- and penalty-free.  You leave the ‘gravy’ in the Roth Account and re-invest it, awaiting age 59 1/2.

WHERE AND HOW – You can find Structured CDs at some banks (Union Bank, Banco Popular) and some online brokerages (Fidelity).  You can also do a web search and find lots of individual (likely high-commission) brokers selling them.  I would steer towards purchasing them from a large bank or brokerage house myself.

 

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