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What Is APY and How Is It Calculated?

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.

What is APY and how is it calculated?
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When looking for a new savings account, do you find yourself confused by the terms, “APY” and “interest rate”? Well, they both have something to do with interest, but they’re calculated differently. Most deposit accounts that pay interest use APY.

Interest rate simply refers to a numerical value (like 1%, 2%, 3%). It is the rate, or percentage, of your original deposit (principal) that the bank pays you in order to hold your money with them.

Annual percentage yield (APY) gives a clearer picture of how much money you can make from your certificate of deposit, savings or money market account than interest rate alone. This is because APY factors in how often the interest is compounded (that is, combined with the principal) over a time period — annually, quarterly, monthly and so on.

Understanding interest and APY

Interest rate

Interest rate and APY are powerful tools. You may be surprised by how much money can accumulate over time — that’s why many experts encourage people to save early. If, instead of withdrawing your earned interest, you let it stay in your savings account, then the interest is calculated on the entire balance, not just on your principal. So as time goes by, you are earning interest on an increasingly bigger pile of money.

Scenario one

If you deposit $100,000 into a savings account that pays 2% interest annually, you will earn $2,000 a year later. When year two starts, your balance will be $102,000. Now, the same 2% interest rate applies to your account, but you will be earning interest on a larger amount — your principal plus the interest you earned during the first year. So, by the end of the second year, your earned interest will be $2,040 — $102,000 x 2% = $2,040, for a balance of $104,040.

If, as in the example above, interest is compounded once per year, then the APY and interest rate are identical — 2%.

Interest plus compounding — APY

However, in practice most banks offer more frequent compounding cycles — quarterly, monthly, weekly or even daily. With daily compounding, for example, your principal amount increases each day as interest is added to it. As a result, your net return is higher.

Scenario two

Let’s take the same $100,000 from the example above and show the APY using compounded interest on a daily, instead of yearly, basis. If the 2% interest on that $100,000 investment compounds daily, then the APY is 2.0201% instead of 2%.

So at the end of the first year, you will have earned $2020 in interest instead of the $2000 that you earned with annual compounding — $100,000 x 2.0201% = $2020, for a balance of $102,020. And at the end of the second year, you will have earned $2060 in interest — $102,020 x 2.0201% = $2060, for a balance of $104,080.

Confused? Not to worry. We just want you to see that the second scenario would earn you more interest than would the first scenario. The key takeaway is that the more frequent the compounding cycle, the more return you can expect by the end of the same time period — that’s why APY matters.

How to calculate APY

We know that this can be baffling for all you non-math geeks! The good news is that most banks provide you with an APY, which saves you the headache of calculating it on your own.

But for those comfortable calculating APY themselves, there are many online calculators that you can use. For example, DepositAccounts.com’s compound interest calculator can help you figure out how much interest you will eventually earn on your investments over certain times. (DepositAccounts.com is a subsidiary of LendingTree.)

And if you’re curious to know exactly how an APY is calculated, you may find the mathematical formula on the Federal Deposit Insurance Corporation’s website.

If you want see how the math works out, here’s the actual formula you can use to calculate APY:

APY = 100*[(1 + (interest rate/compounding cycles)^compounding cycles)) – 1]

Compounding cycles is the number of times a year your interest compounds.

Now if the 2% interest on that investment of $10,000 compounds daily (365 times of a year), at the end of the year, you will earn $202.01 in interest on that deposit.

In this case, the APY is 2.0201%.

Here is how we arrived at the result:

APY = 100 * [(1 + (.02/365) ^ 365) – 1]

APY = 2.0201%

The deposit compounds monthly, meaning it has 12 compound cycles:

APY = 100 * [(1 + (.02/12) ^ 12) – 1] = 2.0184%

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.

Shen Lu
Shen Lu |

Shen Lu is a writer at MagnifyMoney. You can email Shen Lu at [email protected]

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Banking

Understanding the Three Types of Annuities

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.

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Understanding how annuities work is an important first step in determining whether they fit into your retirement plans. Annuities can be customized in many ways, although they fall into three broad categories: fixed, indexed and variable.

An annuity is a contract between you and an insurance company. In exchange for giving the company money today, you receive a lump-sum payment or series of payouts in the future. For example, you could purchase an annuity with a single payment when you retire and then receive monthly payouts for the rest of your life.

Annuities offer long-term, tax-deferred savings, making them a potentially helpful tool for retirement. But because there’s such a wide-range customization available, it can be confusing to understand all your options. Our guide covers the basics on the different types of annuities: fixed, indexed and variable.

What is a fixed annuity?

A fixed annuity is one of the simplest types of annuities — it’s somewhat similar to a certificate of deposit (CD) account. You fund a fixed annuity with a single payment or a series of payments. The insurance company guarantees this principal amount, a minimum interest rate and a number of payments in the future.

The interest rate applies to your principal balance, and your account grows tax-deferred during the accumulation phase. At the end of the accumulation phase, your payout period begins. You’ll then receive a single lump-sum payout or periodic payouts, such as monthly or annually.

“When you first buy a contract for a fixed annuity, the payout amount will be specified,” according to Ken Tumin, founder of LendingTree-owed company DepositAccounts.com, so you’ll know how much income to expect later. Also, depending on your contract, the periodic payouts could be guaranteed for a certain number of years, until you die or until you and a beneficiary (such as a spouse) die.

Fixed annuity pros and cons

Fixed annuity pros

  • This type of annuity is relatively easy to understand.
  • You’ll receive a guaranteed interest rate and payouts.
  • You’ll know the payout amount and payout period when you first buy the contract.
  • There’s little risk of losing your savings.

Fixed annuity cons

  • The interest rate may be lower than what you could receive from other savings or investment products.
  • The interest rate could be lower than inflation in the future.
  • Fees may eat into your savings and decreases your payout amount.
  • You might not be able to take money out of the annuity without paying additional taxes and fees.

Who should invest in fixed annuities?

A fixed annuity may be the most attractive type of annuity if you’re looking for stability and guarantees. However, think carefully about when and why you’re buying the contract, as the interest rate you lock-in during the purchase will influence your payouts.

“If the interest rates start to bottom, it might not be the best time to get a fixed annuity,” said Tumin. “If you think rates are going up, wait for a few years until there’s a better interest rate environment.”

What is a variable annuity?

A variable annuity may feel more like a 401(k) or individual retirement account (IRA) than a certificate of deposit. When you buy a variable annuity, you can choose to invest your money in different financial products, such as mutual funds.

Your earnings during the accumulation phase depend on how well your investments do, which will impact your future payouts. The insurance company may offer optional riders that limit how low your account’s value can drop and guarantee you a minimum payout.

You may also be able to choose to receive the payout as a lump sum, over a fixed number of payouts or until you die. If you choose periodic payouts, the payout amount could either be pre-set or it may vary with your investment returns.

Variable annuity pros and cons

Variable annuity pros

  • You could earn higher returns and have larger payouts than you would with a fixed annuity.
  • Earnings are tax-deferred.
  • The SEC generally regulates variable annuities.

Variable annuity cons

  • You may have to pay higher fees than you would with other tax-deferred accounts.
  • Your payouts count as ordinary income rather than capital gains and may be taxed at a higher rate.
  • You could lose the money you put into the annuity.

Who should invest in variable annuities?

A variable annuity can offer tax-deferred investment growth and an additional source of income during retirement. “But a lot of the best variable annuities are basically a wrapper around investment options like mutual funds,” says Tumin. The wrapper analogy can apply to other tax-deferred accounts, such as 401(k)s and IRAs, although those may offer more investment options and fewer fees.

“For those who’ve maxed out their 401(k)s and IRAs, a variable annuity can be a reasonable option,” says Tumin. Until that point, you may want to focus on investing in other, lower-cost accounts instead.

What is an indexed annuity?

Indexed annuities often offer a minimum interest rate on your money, but are also tied to an investment index, such as the S&P 500. Depending on how the index performs, you may receive more interest earnings than the minimum rate. However, there are also often caps on how much you earn.

For example, if the S&P increases by 8%, you might only receive 3% of the gains — your cap — and the insurance company keeps the remainder. On the other hand, if the S&P decreases in value in a year, you might still receive a minimum interest rate gain rather than losing money.

The specifics of your annuity can also impact your earnings because the contract will dictate the cap, how much of the index’s gains your receive, the fees you’ll pay and how often the insurer reviews the index to calculate gains.

Indexed annuity pros and cons

Indexed annuity pros

  • Offers a mix of guaranteed and investment-based tax-deferred earnings.
  • Limits the potential for losses compared to variable annuities and other investments.

Indexed annuity cons

  • Although your money gets invested, the SEC and FINRA might not regulate indexed annuities.
  • Your gains are limited by the insurance company’s fees and caps.
  • Can be particularly hard to understand and compare to other savings and investment options.
  • Although there could be minimums, you might lose money on your investment.

Who should invest in indexed annuities?

Index annuities can seem like the best of both worlds — protection against investment losses with the potential to earn more than you would with a fixed annuity. But it’s not all good news, as the fees and caps can eat into your potential investment returns, particularly during high-growth periods.

“For those that are very conservative, the indexed annuity could give you a better return than a fixed annuity,” says Tumin. However, as with variable annuities, he suggested looking into other tax-deferred investment accounts, such as 401(ks) and IRAs, before an indexed annuity.

Deferred annuity vs. immediate annuity: What’s the difference?

You can purchase these three types of annuities as either deferred or immediate annuities.

With a deferred annuity, your contract begins with an accumulation phase. During this phase, the interest or investment earnings get added to your account balance, and you may be able to make additional contributions to increase your account’s value. At the end of the accumulation phase, you’ll start to receive payouts (either in a lump sum or periodically) based on the account balance and the terms of your contract.

Immediate annuities start to pay immediately based on your payment schedule. So, if you receive payments monthly, your first payment will start a month later. But if you receive annual payments, you’ll wait a year for your first payment.

Deferred annuities can be a better option if you’re planning ahead for retirement, or are in retirement but have other sources of income. An immediate annuity may be a better option if you’re in retirement and want to lock-in an income stream.

Conclusion

There are different types of annuities, payout structures and a wide range of riders that can make comparison shopping extremely difficult. Add on the fees, brokers’ commission-based sales arrangement and the possibility of losing your “guaranteed” income stream if the insurance company goes under and annuities look much less appealing.

Still, that’s not to say annuities are all bad. An annuity can offer a steady income stream during retirement, with an option to continue the income stream as long as you’re alive (or even beyond).

However, if you’re considering purchasing one, continue doing your due diligence and learning about the differences between annuity providers and contracts.

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.

Louis DeNicola
Louis DeNicola |

Louis DeNicola is a writer at MagnifyMoney. You can email Louis at [email protected]

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Banking

How to Handle Financial Infidelity in Your Relationship

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.

For relationship partners, dishonesty about spending and debt is known as financial infidelity. While partners may be uncomfortable talking about money, keeping secrets can be far more damaging to the relationship. This can lead to devastating scenarios and even bankruptcy, as well as relationship conflicts as severe as breakups and divorce.

A MagnifyMoney study found that 21% of divorced U.S. adults report that money issues ended their marriages, and overspending was the top issue among respondents. This type of infidelity adds another layer of damage because it constitutes a betrayal of trust.

“Financial infidelity does not give us trust and safety with our partner,” said Dr. Bonnie Eaker Weil, Ph.D., psychotherapist and author of “Financial Infidelity: 7 Steps to Conquering the #1 Relationship Wrecker.” “There’s no such thing as an okay financial fib. Any time you do a financial fib, that is a form of cheating.”

That being said, there are varying degrees of financial infidelity, and the intent is not always malicious. Here’s how to handle it in your own relationship.

Financial infidelity: How people lie about money

There are a number of ways that people can be dishonest about money with their partner. Here are some types of financial infidelity to watch out for.

Hiding large purchases

This occurs when one partner buys something out of the ordinary that is more expensive and exceeds any personal spending limits the couple has agreed upon. These purchases are usually eventually uncovered by the other partner, said Jennifer Dunkle, a financial therapist and licensed professional counselor.

Spending money on the kids

A 2018 study about financial infidelity published in the Journal of Financial Therapy found that one of the most common types of dishonest spending is money spent on the couple’s children without agreement or knowledge from the other parent, said Dr. Michelle Jeanfreau, Ph.D., associate professor, licensed marriage and family therapist and the author of the study. While this might seem relatively benign or well-intentioned, it’s still a form of dishonesty, and it warrants a closer look into your finances.

“If you aren’t talking about spending, then maybe that’s a sign that you need to be talking about spending,” said Jeanfreau.

Hiding accounts or restricting access to accounts

It’s okay to keep separate accounts from your partner as long as you are in agreement about spending limits, according to Justus Morgan, certified financial planner and vice president of Financial Service Group.

But if your partner has an account that you don’t know about or refuses to give you the password to oversee an account, that’s a form of financial infidelity. You and your partner are a team, so even if one of you is more comfortable managing your finances, you should both have access to all of your financial information.

Lying about prices or sales

Maybe your partner comes home with a new purchase, and instead of hiding it from you altogether, they lie about the price they paid. Or, perhaps they say they bought it on sale when they actually paid full price.

These are both common lies that emerged during the previously mentioned 2018 study. While it may not seem as malicious as hiding a purchase, lying about price still creates dishonesty in a relationship.

Why people lie about money

In the 2018 study, some participants identified acts of financial infidelity they’d committed but didn’t admit to having been financially unfaithful. Jeanfreau said that could be because they don’t realize that their small secret or lie is actually a form of financial infidelity that can be damaging to their relationship. Another possibility, she said, is that they don’t think there’s anything wrong with this type of infidelity.

In a new study authored by Jeanfreau that is under review, researchers identified two common reasons why people commit financial infidelity. One motive for lying may be avoiding a money argument, while another reason is that people want to spend on themselves. Both motivations can indicate underlying problems with a relationship, Jeanfreau said. She also noted that some people may lie to minimize their own insecurities about spending or budgeting if they feel they don’t know how to self-spend within reason.

How to uncover financial infidelity in your relationship

So, how do you find out if your partner is keeping secrets from you? Morgan suggests looking at tax returns and credit reports together annually. It’s a healthy habit for any couple, and it should reveal missing income that was spent on a hidden purchase, as well as any credit card accounts opened without one partner’s knowledge.

If you’re concerned more immediately, you may want to ask your partner to review bank statements, credit card statements or other financial statements together. If your spouse isn’t willing to provide these statements, that should raise a red flag, said Morgan.

What causes financial infidelity?

The outcomes of this type of infidelity can range from running up a credit card to bankruptcy to even divorce. So, you’ll want to know what aspects of a relationship can make financial infidelity more likely.

Eaker Weil said opposites attract to begin with, and a saver often attracts a spender and vice-versa; this can create a dynamic ripe for conflict, so understanding your differences is key. She also said that financial infidelity often arises from a lack of empathy or affection for one another: “We use money to hide when we can’t find our partner’s heart very often.”

Both Dunkle and Morgan pointed to a power imbalance as a factor that can increase the likelihood of dishonesty. When one of the spouses is more controlling about money decisions — especially if the spouse earns more and has the attitude that it’s their money — that can create an unhealthy dynamic, Morgan said.

Preventing financial infidelity

Morgan said one of the keys to establishing a healthy relationship around money is to recognize that everyone has different experiences when it comes to money, and that family upbringing often teaches us how to deal with money when we lack more formal instruction.

Eaker Weil even recommends that couples create a family tree with help from their parents and grandparents and share their findings with their partner. This should help to answer questions: how was money handled in each person’s background? Was there fear or deprivation around money? Did people put their family needs before their own? These questions can help predict people’s attitudes about money, an important topic of discussion among couples.

“If you’re able to really understand your own values and beliefs around money, then you’re going to be able to talk to your partner about goals and expectations for your finances,” said Jeanfreau.

She added that financial education should be a part of counseling for newer couples planning to join their finances. If couples learn early on how to communicate with transparency, find a system that works for them, develop a budget and plan and review their finances regularly, it can help prevent financial infidelity behaviors from the start.

Recovering from financial infidelity

This type of infidelity doesn’t have to be the end. But it should trigger a serious discussion, a review of your financial situation and possibly even help from professionals.

Eaker Weil recommends a weekly money talk for couples who have experienced financial infidelity. She said it’s important to approach these conversations with curiosity instead of being reactive, hurt or angry about your partner’s financial infidelity.

But sometimes, the way we talk about it can actually make relationship problems worse. Dunkle said there are four destructive patterns in a relationship that need to be corrected when they occur: criticism, defensiveness, contempt and stonewalling.

Replacing those patterns by talking about your own feelings, describing the situation neutrally and describing what you want from your partner positively, rather than negatively, can help couples to move on from a financial infidelity incident. Dunkle also stressed the importance of attending couples therapy, since recovering from financial infidelity can be difficult to manage on your own.

Jeanfreau said the SAFE model is another way for couples to recover from this type of infidelity. It’s a four-step process that involves the following:

  1. Speaking the truth, or coming clean about financial infidelity
  2. Agreeing to a plan, which involves setting up a budget
  3. Following that agreement and regularly reviewing it
  4. Having an emergency plan, which usually includes seeking the help of therapists or financial advisors

Don’t assume the worst of your partner. Find out what their intention was, and try to have empathy for their situation. And remember that it’s okay to ask for help. It happens to couples everywhere, and love for each other alone can’t prevent or repair it. It may take patience and a lot of work to get back on track, but financial infidelity doesn’t need to destroy your partnership.

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.

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Lindsay Frankel |

Lindsay Frankel is a writer at MagnifyMoney. You can email Lindsay here