One of my “Snowbird” clients called me from Florida and asked me what I knew about Equity-indexed CD’s. When I asked if she meant Equity-indexed Annuities, She said, “No, I was approached by this stockbroker who offered me an FDIC insured Equity-indexed CD. He said it would pay higher interest then a regular CD and I could buy it through his firm and not a bank”. Intrigued I started looking into this hybrid CD only to find several different types of CDs being marketed by either Banks or Brokerage firms. What I found was both interesting and very confusing.

In addition to the traditional fixed-rate CDs there are now several of these hybrid CDs in which investors can choose from: equity-indexed CDs; variable-rate CDs; jumbo CDs; callable CDs and others with a mixture of a little of one blended with a little of another. Each promises a higher rate of return then traditional CDs coupled with the backing of the FDIC (Federal Deposit Insurance Corporation). Although these products are legitimate in nature there is great concern regarding the confusion generated by them and how they are marketed.

When the North American Securities Administrators Association (NASAA) issued its “Top Investor Traps” for 2006 these hybrid CDs were near the top of the list. In their report the NASAA stated that “the risk isn’t the product, but the way it’s marketed”. Their concern was that seniors would just hear “certificate of deposit” and not fully understand what they were actually buying. These hybrid CDs are not suitable for those who need a guaranteed return for retirement income.

You also have to be careful because you may find that your CD really isn’t as FDIC protected as you thought. One way Brokerage Houses buy these CDs is in bulk from the issuing Bank, then sell off small pieces to individual investors. But the total amount owned by the Brokerage House is what counts and that could very well be far in excess of the $100,000 limit imposed by FDIC.

Another problem is confusion over the actual maturity date of the CD. With callable CDs there is a maturity date and a callable date. A callable CD can be “called in” by the issuing bank before its maturity date and has a specific call date on it, usually within 1 year and then after some future period of time as well. If not called it will continue until the maturity date which could be some time very far into the future (there is one that has a 30-year maturity date). So when you think you have a 1 year CD and go to get your money you find out that was the call date and you can’t withdraw your funds without a significant penalty or that you can’t get to it at all.

Equity-indexed CDs relay on a specific stock indices such as the S&P 500 or the NASDAQ to determine the rate of return the CD receives each year. Although the principle should be protected there is a risk that you may not receive any return at all if the market has a significant down turn and with fees that are charged to sell the CD you could loss principle as well.

Although these hybrid CDs don’t fall into the same category as some of the other scams we’ve looked at in past articles they certainly do fit the bill of “buyer beware”. If you are looking into one of these CDs please make sure you understand all about them and when you can get to your money and at what cost. Find out the early withdrawal penalties for cashing in before maturity. Know if the interest rate fixed or variable and how the interest is paid. Get it in writing and don’t sign on the dotted line until all your questions have been answered. Remember the greater the promised reward the greater the risk.

Fred L. Goldenberg is a Certified Senior Advisor and the owner of Senior Benefit Solutions of Michigan. He is also a founding member of the Senior Resource Alliance of Northern Michigan.