Annuities and certificates of deposit (CDs) are good options for people who want to invest a sum of money for an extended period without a lot of risk.
Certificates of deposit, which are less complex and less flexible than annuities, are financial products.
Annuities, on the other hand, are insurance products. They are often more complicated than CDs because there are so many ways to customize them to meet your needs.
Certificates of Deposit Explained
A CD is a financial product that holds a single deposit of money for a fixed period of time. Most CDs pay interest monthly. When purchased through a federally insured bank, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000.
Annuity and CD Features: A Comparison
Before choosing whether to buy an annuity or a CD, research your options — including the many ways you can customize an annuity to meet your needs.
Comparing Annuities and CDs
|ANNUITIES||CERTIFICATES OF DEPOSIT|
|General Purpose||Retirement income||General savings|
|Taxation||Grow tax deferred||Interest taxed annually|
|Safety||Backed by insurance company/state||Backed by FDIC|
Similarities Between Annuities and CDs
Multi-year guaranteed annuities (MYGAs) are the most similar to CDs. Like a CD, a MYGA ties up a lump sum of money and allows it to accumulate interest. At the end of the accumulation period, the customer receives the principal and interest earned.
MYGAs are fixed annuities. Fixed annuities, overall, have commonalities with CDs, including a guaranteed rate of return and a guarantee on the principal. Compared with investments such as stock funds, fixed annuities and CDs have relatively low rates of return and high levels of safety.
Other types of annuities, such as indexed and variable annuities, can grow at rates determined by the investments in their subaccounts or the performance of an index, such as the S&P 500. They have different risks and costs than fixed annuities, as well as the potential for greater growth, which makes them less comparable to CDs.
Read More: How to Diversify Your Portfolio
Differences Between Annuities and CDs
In some states, annuities are exempt from lawsuit claims. This is not the case with CDs.
Annuities are designed to pay a stream of income over time — in some cases, for life — rather than a lump sum at maturity. This is a major difference between annuities and CDs.
Life annuities pay out for the rest of the owner’s life, even in cases where the entire principal amount has been paid out.
Safety and Risks
Bank CDs are considered an extremely safe investment because the FDIC insures them up to $250,000.
Although annuities are not insured by the federal government, they’re also considered safe because they’re insured by the issuing insurance company and, in most cases, also by state guaranty associations. It is important to make sure your annuity is issued by a highly rated insurance company.
Interest rates for CDs are generally lower than interest rates on annuities. Under current low interest rates, a 1 or 2 percent higher interest rate can make a big difference.
Annuities grow tax-deferred. CDs do not. Tax deferred growth means the interest compounds, so you earn interest on the funds that would have been used to pay taxes.
The IRS requires that the earnings on CDs not held in tax-preferred retirement accounts are taxed annually.
Liquidity and Penalties
Annuities are not as flexible as CDs, and they have higher penalties for early withdrawals of more than 10 percent of value of the contract.
If you close a CD earlier than scheduled, the penalty you pay is lower than the penalty you would pay if you were to withdraw funds early from an annuity.
And whereas penalties for early withdrawals from a CD typically increase each time the CD is renewed, penalties for early withdrawals from an annuity are fixed.
In addition to the penalties imposed under the annuity contract, annuity owners under the age of 59½, must pay the IRS a penalty of 10 percent for early withdrawal from an annuity.
Annuity beneficiaries are not required to go through probate court in the event of the annuity owner’s death to claim their benefits.
If certificates of deposit are not placed in a living or irrevocable trust, heirs must go through probate if the CD owner dies.
Read More: Passive Income Streams
Interested in Buying an Annuity?
How to Choose Between an Annuity and a CD
When deciding whether to put your money in a CD or an annuity, you should, of course, consider your needs.
If you plan to use the money you’ve invested to provide a stream of retirement income, an annuity is the obvious solution for you.
Remember, though, that annuities also allow you to have your principal and interest returned to you in a lump sum, just the same as a CD allows.
Other preferences that will affect your decision include:
- Do you want your investment backed by the federal government or the insurance company?
- How long are you willing to have your money invested in the product?
- What are you planning to do with the money once you collect it?
- How diverse is your portfolio and what is your financial strategy?
- Are there annuity provisions, such as long-term care riders, that will let you customize your contract to meet your needs?
You should review your needs and expectations with your financial advisor before making any decision to tie up a significant portion of your savings.