Do market-linked CDs offer high rates?

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Rates can’t stay ultra-low forever, right? Hopefully not; savers have been waiting a very long time for higher rates on certificates of deposit.

To make up for the lost interest, savers have been casting long lines for yield and taking on more risk. One way of doing that has been with market-linked CDs.

The hybrid CDs often promise the best of both worlds: the upside of the stock market, or some other index such as commodities or currencies, with the principal-preserving guarantees of a CD. But market-linked CDs, also called indexed or structured CDs are much more complicated than their plain vanilla counterparts.

Here’s what you should know

The actual return you receive from a market-linked CD won’t be apparent until the CD matures.

But depositors don’t typically receive all of the returns served up by the index the CD tracks — if there are any. Instead the amount the CD pays out is usually limited based on the participation rate, or the number of people who buy the CDs.

CDs that are linked to an equity index come with some other drawbacks, including the fact that investors won’t receive any dividends from the stocks in the index the CD is linked to.

“Unlike the equity market, there isn’t a big market for an equity-linked CD. Investors should have longer term time horizon and hold to maturity,” says Froilan Rellora, chief investment officer at Catalina Asset Management in Mesa, Arizona.

Fees for breaking the CD early could be astronomical. In some cases, it may not even be possible to withdraw funds early.

Watch out for taxes

The taxes can be a disappointment as well: CD interest is taxed as income rather than a capital gain as stock returns would be taxed. If savers get lucky with a CD that pays out generously, taxes will take a bite. But that’s not all, investors must pay taxes on the estimated yield each year they hold the CD, even though there’s no guarantee they will get that return upon maturity.

For such a simple product like a CD, the market-linked version comes with all manner of caveats and complications.

In 2012, the Federal Deposit Insurance Corporation issued a warning on market-linked CDs.

Have you had good experiences with market-linked CDs? Please tell me about them in the comments.

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Senior investing reporter Sheyna Steiner is a co-author of “Future Millionaires’ Guidebook,” an e-book written by Bankrate editors and reporters. It’s available at all the major e-book retailers.