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Market-Linked CDs: What They Are and If They Are Right for You

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

There are only so many low-risk saving options that keep your money safe and also provide a nice return. High-yield savings accounts and certificates of deposit (CDs) are the most common ways to grow your funds without worrying about losing principal. Meanwhile, the stock market offers the possibility of higher returns in exchange for much greater risk. What if there were a way to access the richer returns of public markets together with the low-risk security of a CD?

Market-linked CDs are designed to address this very need. With these types of CDs, your principal investment gets the security of a traditional CD as well as the possibility of extra gains when the stock market outperforms. Sounds great, right? Beware, market-linked CDs are somewhat difficult to understand. Read on to learn all the details.

What is a market-linked CD?

Also known as index-linked or equity-linked CDs, market-linked CDs are certificates of deposit with variable interest rates, determined by the stock market. While a conventional CD offers a set interest rate for the term of the deposit, a market-linked CD’s rate of return fluctuates over its term.

The rate of return on a market-linked CD is dictated by the performance of a stock index like the S&P 500, by a basket of individual stocks, or by a combination of indices and stocks. If the underlying index or stocks perform well, the amount you make from these CDs rises. But if they do poorly, you make less — and in some cases your rate of return can go to zero.

“Market-linked CDs are getting more interest because of volatile markets,” says Tom Balcom, founder of 1650 Wealth Management, a Florida-based financial advisor. “It’s a product that at certain times is more desirable for investors.”

These CDs are usually offered for a term of at least five years, with some terms even going out to 20 years. Similar to a conventional CD, investors will be charged a penalty for early withdrawals. However, market-linked CDs are “callable,” which means the issuing bank can choose to redeem it before its maturity date.

How do you determine your rate of return on market-linked CDs?

It can be challenging to understand the total rate of return available from a market-linked CD. While the amount you earn is determined by the performance of an underlying index or group of stocks, there are two limitations on your rate of return: the participation rate and the interest rate cap.

  • Participation rate: Your annual rate of return is on a market-rate CD can be restricted to a percentage of the gain in the underlying index or basket of stocks. The participation rate describes this percentage. If a market-rate CD is based on the S&P 500, which sees a 15% gain in one year, and the certificate has a participation rate of 75%, the CD produces a return of 11.25%, or 75% of 15%. Alternatively, a 100% participation rate would give you the whole 15% gain in one year.
  • Interest cap: The rate of return on market-rate CDs can be subject to an annual interest rate cap. If the S&P 500 gains 15% in one year, but the interest cap on a market-rate CD based on this index is 10%, then the CD would only return 10% — even though the S&P 500 gained 15%.

As we all know, stock markets go down as well as up. Losses in indices or stocks on which a market-rate CD are based do not touch the principal investment. However, stock losses mean that your rate of return can be zero. In cases like this, you would have lost out on the opportunity to invest the same money in another investment, like a conventional fixed-rate CD, with a guaranteed return over its term.

Your total return on a market-linked CD is calculated using one of two methods. The point-to-point method looks at the starting value of the underlying index or basket of stocks when the CD is issued and their ending value at maturity. The difference between the two numbers will indicate your return rate — modified by the participation rate and any interest rate cap. The average method averages the value of the index or basket of stocks on regular dates throughout the term of the CD  — also modified by the participation rate and any interest rate cap.

Pros and cons of market-linked CDs

With so many moving parts, these CDs are an interesting investment product — one with several pros and cons.

Pros

  • Stock market exposure: Investors who want to participate in the market, but are afraid of the potential losses can get a taste of the opportunity. Your principal will not be at risk of the linked index or equity has negative performance.
  • Access to a variety of asset classes: CD investors can get exposure to potential gains from a wide variety of asset classes, like stocks, bonds, currencies and commodities.
  • FDIC insurance: Principal invested in a market-linked CD is insured up to the FDIC maximum of $250,000. However, the FDIC insurance does not cover speculative investments, so it does not insure any speculative market gains above and beyond your principal.

Cons

  • Underperforming returns: Market-linked CDs can underperform conventional CDs after deducting fees and caps. After analyzing the performance of 118 market-linked CDs, the Wall Street Journal discovered that only a quarter outperformed conventional five-year CDs, and about a quarter paid no return at all.
  • Higher taxes: Even though the CD is linked to the market, gains are returns are considered interest and not capital gains. While long-term capital gains have a 15% tax rate, interest on a market-linked CD is taxed at your income tax rate, which is likely to be higher than capital gains. In addition, you must declare interest each year, instead of at maturity, which means you must pay taxes before potential gains are realized.
  • Liquidity: These CDs are usually held for a term of five years. If you need the money, you will pay a high penalty for early withdrawal. It’s important to consider your liquidity and income needs before investing in a market-linked CD.

Should I invest in a market-linked CD?

Investors are often interested in market-linked CDs because of their potential to deliver higher returns than conventional CDs. While this is true if the market is performing well, a down market could tie up your money with little or no return.

However, if you want to take a chance on a higher return than a conventional CD, a market-linked CD might be worth the investment. “If you’re a Nervous Nelly about the market and say, ‘Oh, I don’t want to invest in the market because I could lose money,’ this is a good investment tool for you because it provides you with some exposure to the market, but not the downside exposure,” says Balcom.

What are my other CD options?

Conventional CDs and market-linked CDs are just two of your CD options. Another product is a jumbo CD, which requires an initial deposit of $100,000 and offers a higher rate of return than a conventional CD. A no-penalty CD allows you to access your money before the end of the term without penalty. A bump-up CD lets you switch your CD for one offering a higher rate if it comes available during your investment period. And a brokered CD is offered by a middleman, such as a stock broker or financial advisor who buys CDs in bulk from banks, negotiating higher rates.

The bottom line

Market-linked CDs offer the principal protection of a conventional CD with the potential of higher returns. Unfortunately, those returns aren’t guaranteed. Choosing this product comes down to your tolerance for risk, says Balcom.

“Anybody that wants a higher return than offered with bank CDs, this would be a better product for them,” says Balcom. “Somebody who says, ‘I’m worried about the market’ and ‘We’re in near-all-time highs; I don’t want to lose money,’– if they use those terms or phrases – it’s possible this is a good product for those individuals.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Stephanie Vozza
Stephanie Vozza |

Stephanie Vozza is a writer at MagnifyMoney. You can email Stephanie here

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Banking

Powerball Annuity vs. Cash: How Does It Work and Which One Should You Take?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Feeling lucky? You’ll need luck — and lots of it — to win the Powerball lottery jackpot. The odds of taking the grand prize are 1 in more than 292 million, according to Powerball. While those chances are pretty slim, someone has to win. It could be you, right?

Let’s daydream for a moment and say you do hit it big. One of the many decisions you’d have to make is whether you’d take your winnings in a Powerball annuity or a lump sum. Most people want their money now, but don’t cash that check quite yet. You’ll want to think through the two options wisely to make the right choice.

Powerball annuity: How it works

If you win the Powerball jackpot, you can choose to receive the jackpot in an annuity that is paid in 30 graduated payments over 29 years with an annual interest rate of 5%. An annuity calculator can help you determine your payout amounts over time.

As of this writing, the estimated Powerball jackpot is $112 million. Using this scenario, your immediate annuity gross payout would be $112 million — before federal and state taxes. Because of the 5% increase each year, the second year you would receive $1,770,049, and the third year you would get $1,858,551. Your annual payments would continue to grow by 5% each year until your final payment of $6,938,820.

Of course, you’d owe taxes on your winnings. This income would put you in the highest federal tax bracket, which is currently 37%. Note that the IRS will automatically take 24% of your winnings, and then you’ll owe the rest when you pay your taxes. You also could owe state taxes, which will vary depending on where you live. New York has the highest rate at 8.82%, while some states, like Tennessee and Texas, don’t tax lottery winnings at all.

Powerball lump sum: How it works

Just like it sounds, the lump sum option pays out the cash value of the jackpot all at once. In the case of the $112 million Powerball pot, the cash value is $75.4 million.

Unlike the annuity that is taxed as you receive your annual payments, the winner who takes the lump sum pays all applicable taxes upfront. A winning ticket would put you in the highest tax bracket, which is currently 37%, netting you $47,502,000 before state taxes, which vary depending on where you live.

No matter how you decide to take the money, if there is more than one winning ticket, the pot is divided equally. If you’re the sole winner, you get the entire amount.

Powerball annuity vs. cash: Which should I choose?

One prize does not fit all when it comes to the lottery, and the answer to the question of Powerball annuity vs. cash is situation specific.

Annuity advantages

It’s not uncommon to hear about lottery winners who go broke just a few years after collecting their prize due to mismanagement of the funds. If you’ve had money trouble before, consider the annuity.

“If I meet winners that appear to me to be extremely undisciplined with their investments, I recommend the annuity as a way to protect them against themselves,” said Jason Kurland, a Uniondale, N.Y.-based attorney who has counseled large-jackpot winners, including the anonymous South Carolina winner of the $1.5 billion Mega Millions jackpot. “I call these winners my ‘drunken sailors.’ If they are talking about buying mansions, expensive cars, vacations for all of their friends and family in the first month, perhaps an annuity is the way to go.”

Edward Snyder, CFP and cofounder of Oaktree Financial Advisors in Carmel, Ind., agreed. “For someone who might blow through the money, the annuity makes sense,” he said. “You could still blow through it every year, but it will take you 30 years.”

Taking the annuity would give you a regular, guaranteed income for the next 29 years, which is a definite advantage. And you’ll avoid a massive lump-sum tax bill as well as additional taxes on investment gains you’d pay over the years if you were to invest that lump sum.

Lump sum advantages

One major reason to take the lump sum is the potential for growth if you invest the money. “If a winner can conservatively invest their lump sum amount, their fortune will grow at a much quicker pace than if they wait for the annuity payments from the lottery,” said Kurland. “If interest rates go up considerably, the annuity option could become a bit more attractive, but right now, given the low interest rate environment, it makes more financial sense to take the lump sum.”

Another reason to take the lump sum is the current tax climate, said Snyder. “We are at the best situation tax-wise we’ve ever seen,” he said. “Our current tax rate is temporary, though, and rates are set to go up in 2026. The lump sum today would be in the 37% bracket. If you took the annuity, you might be paying higher taxes later.”

If the winner is older, the lump sum also offers an advantage for his or her heirs, said Kurland.

“If a winner dies while receiving the annuity payments, their estate could be hit with a huge tax that it can’t afford,” he said. “The tax will be similar for a lump sum winner, but at least the money will be there to pay it. An estate may not have the luxury of waiting for the annuity payments in order to pay the tax. There have been instances where this actually bankrupted an estate for a winner who chose the annuity payments.”

And then there’s the matter of control. If you take the lump sum, it’s up to you to decide how to invest it.

Powerball FAQ

The Powerball is “annuity certain,” which means if the winner dies before receiving all of the installments, the balance of the prize is transferred to his or her estate. Upon receipt of a court order, the balance will continue to be paid to the heirs each year.

If you win the big jackpot, you must claim your prize at the lottery headquarters for your state. Smaller prizes can be claimed at regional offices.

Depending on the size of your prize, the expiration date varies. If you win the Powerball grand prize, however, the expiration date is 90 days to a year, depending on your state’s rules.

If you live in Arizona, Delaware, Georgia, Kansas, Maryland, Michigan, Texas, North Dakota, Ohio and South Carolina, the answer is yes, if the winnings are above a certain amount. New York allows lottery winners to create an LLC through which to accept the funds, to provide anonymity. If you live anywhere else, your name will be released.

Unfortunately, yes. Scammers reach out to potential victims by email or phone to try to convince you that you’ve won a prize and must pay a fee to collect it. Lottery officials will not contact you to inform you that you’ve won a prize, unless you specifically entered an official lottery promotion or contest.

Scammers are also creating social media posts that say Powerball is giving away prize money on Facebook. These notices are also fraudulent. Lotteries do not contact prize winners through Facebook, unless you specifically entered an official lottery promotion or contest.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Stephanie Vozza
Stephanie Vozza |

Stephanie Vozza is a writer at MagnifyMoney. You can email Stephanie here

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Banking

How to Spot a Fake Check

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

With so many forms of electronic payment available today, you probably don’t write many personal checks anymore. Nevertheless, checks are an increasingly popular vehicle for scammers trying to swindle people out of money.

According to the National Consumers League (NCL), fake check schemes were the third most popular scam committed in 2018. The Federal Trade Commission (FTC) found that reported check fraud cases in 2018 represented a loss of $75 million. The FTC reported a median loss of $1,214 per fraud.

“Fake check scams have been a serious consumer issue for years, and it’s one that continues to be with us with the nature of the scams evolving,” says John Breyault, NCL’s vice president of public policy, telecommunications and fraud.

Scammers use counterfeit personal checks, cashier’s checks and even certified checks for fraudulent activity. So even if you trust a person you’re doing business with — and the check they hand you looks legit — it’s important to look beyond the dollar signs and verify that any check is legitimate.

Beware common fake check schemes

“Check fraud used to entail someone stealing checks out of the mail and forging them,” says Jim Wilcox, assistant vice president of risk operations for Affinity Federal Credit Union, in Basking Ridge, N.J. “But with the internet and the passing of remote deposit captures, the opportunities and means by which people use fake checks to commit fraud has grown exponentially.” These are the four most common fake check schemes:

Foreign lottery scams

With the foreign lottery scam, you get an email or letter that informs you that you’ve won a foreign lottery or received an inheritance from a distant relative. The scammer sends you a check and asks that you deposit it in your bank account and wire back money to pay fees or foreign taxes. The fake check eventually bounces, but you’ve already sent the scammer some of your own real money.

Internet auction scams

This scam targets people selling cars or other high-priced items via online classified ads. The scammer replies to your post and sends you a check, but it’s for more than your sales price. The scammer will claim they made an error in filling out the fake check and request that you deposit it anyway and refund the extra via wire transfer. Their check bounces, leaving you missing the amount you “refunded.”

Check repayment scams

The check repayment scam is similar to the internet auction scam, but this time the scammer who wants to purchase your item says that they’re owed money from a third party who will send their money directly to you in repayment. However, the fake check is for more than the purchase price, and you’re instructed to wire them the difference.

Secret shopper scams

With this gem, scammers tell you that you’ve been hired as a mystery shopper to evaluate the services of a money transfer company. You’re sent a check to deposit into your checking account, then asked to withdraw the money and wire a portion to a specific person. You’re told to “keep” a portion for your services. The fake check bounces and you’re liable for the money withdrawn, which can be several thousand dollars.

How to protect yourself from a fake check

Protecting yourself from fake checks and check fraud means being cautious about accepting checks from anybody you don’t know. There are several steps you can take to ensure you don’t fall victim of a check fraud scam.

Examine the check

First, look very closely at any check you receive — personal, cashier’s or certified. Cashier’s checks used to be as good as gold, says Wilcox, but they’re one of the most common forms of fake checks today. Scam artists often use sophisticated technology to create checks that look real, but here’s what to watch for:

a

Confirm that the payee’s name and the person giving you the check match.

b

Look for security features, such as watermarks.

c

Check for a perforated edge, such as where it’s been torn from a checkbook or register. Counterfeit checks often have smooth edges because they’re printed on a computer.

d

Make sure the check includes the bank logo and address, and that both are correct.

e

Look at the magnetic ink character recognition (MICR) line on the bottom of the check, which will include the bank routing number, the account number, and the check number. Match the routing number to the issuing bank by searching the American Bankers Association website.

f

Look at the paper. Real checks are printed on matte sturdy paper.
  • Confirm that the payee’s name and the person giving you the check match.
  • Look for security features, such as watermarks.
  • Check for a perforated edge, such as where it’s been torn from a checkbook or register. Counterfeit checks often have smooth edges because they’re printed on a computer.
  • Make sure the check includes the bank logo and address, and that both are correct.
  • Look at the magnetic ink character recognition (MICR) line on the bottom of the check, which will include the bank routing number, the account number, and the check number. Match the routing number to the issuing bank by searching the American Bankers Association website.
  • Look at the paper. Real checks are printed on matte sturdy paper.
  • Rub a damp finger over the printed areas of the check to make sure they don’t smear.

Ask yourself if the check source is legit

If you receive a check in the mail or from someone you didn’t contact, take time to investigate who’s giving you money and why. Research the person or company to see if the payment makes sense and check any emails you had with them. Mystery shopping is a legitimate working opportunity, but companies that hire shoppers don’t send checks in advance. Verify that the mystery shopping opportunity is real by checking with the Mystery Shopping Professionals Association.

Do not spend the money before the check is verified

Don’t cash the check right away, but if you need to cash it, hold on to the money and do not spend it. If the check is fraudulent and bounces, your bank has the right to withdraw the funds from your account, which can leave you with a negative balance and overdraft fees.

Under federal regulations, banks must make funds available within one to five days, depending on the type of check. A government or cashier’s check, for example, must be cleared one business day after you deposit the check, which is why they’re commonly used in check fraud. Unfortunately, fake checks can take weeks to be identified.

“The account number and routing number might not jive, and the check could be bounced around in an attempt to be routed to the right bank, adding time to clearing,” says Wilcox.

Report suspected fraud

If you have been the victim of check fraud or you think you’re being scammed, report it. It’s embarrassing to admit you’ve been duped, but scammers won’t be caught if no one reports the activity. Take these steps:

Who’s responsible for a fake check?

It’s bad enough to have fallen victim to a scam, but ultimately you’re responsible for any check you accept and deposit, says Breyault.

“If you wired money, it’s gone and practically impossible to get it back,” says Breyault. “The bank will want to be repaid, and that will fall on the consumer to shoulder the cost.”

The final word on fake checks

Scammers will continue to use fake check schemes as long as they can find willing victims. Don’t fall for their schemes. Scrutinize any check you receive, especially if it comes out of the blue, as with the inheritance scam, or it’s written for more than the selling price during a transaction. If the windfall is too good to be true, it probably is.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Stephanie Vozza
Stephanie Vozza |

Stephanie Vozza is a writer at MagnifyMoney. You can email Stephanie here