Fixed Annuities vs. CDs: Which is the Better Investment for You?

While both a Fixed Indexed Annuity and a Certificate of Deposit (CD) are fairly conservative, choosing the right one depends on duration and flexibility. For a shorter time horizon and more flexibility, a CD is ideal. For a long-term outlook and ongoing income, a Fixed Indexed Annuity is more suitable.

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  • Written By Anthony DeLuca, CFP ®, CDFA®
    Anthony DeLuca, CFP ®, CDFA®

    Anthony DeLuca, CFP ®, CDFA®

    Senior Financial Advisor with Delta Advisory Group

    Anthony DeLuca is a CFP® Professional and a Certified Divorce Financial Analyst® Professional. As a Senior Financial Advisor with Delta Advisory Group, he adeptly manages a remarkable $170 million in client assets and plays a pivotal role in Delta's 401(k) team, guiding and educating participants towards financial empowerment. In addition to his professional qualifications, he holds several security licenses, including the Series 65 - National RIA, Series 7 - General Securities Representative, Health, Life and Variable Annuity License, as well as the General Securities Principal License - Series 24.

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  • Edited By Michael Santiago
    Michael Santiago
    Headshot of Michael Santiago, senior editor for

    Michael Santiago

    Senior Financial Editor

    Michael Santiago is a skilled writer and editor with over a decade of experience in various industries. As a senior financial editor, he collaborates with a team of experts to develop compelling and accurate content.

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  • Reviewed By Paul Garofoli, FLMI, RICP®
    Paul Garofoli, FLMI, RICP®
    Paul Garofoli, FLMI, RICP® - Expert Contributor

    Paul Garofoli, FLMI, RICP®

    Regional Vice President for Individual Annuities at Standard Insurance Company

    Paul Garofoli, with 40+ years of industry expertise, serves as the Regional Vice President for Individual Annuities at Standard Insurance Company. A notable advocate, he was elected to the Board of Directors for NAFA. Garofoli holds a Bachelor's in Political Science and Economics from the University of Massachusetts Amherst.

    • Over 40 years of industry experience
    • Regional Vice President for Individual Annuities at Standard Insurance Company
    • Elected to the Board of Directors for the National Association for Fixed Annuities (NAFA)

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  • Updated: June 18, 2024
  • 8 min read time
  • This page features 4 Cited Research Articles

Key Takeaways

  • Both Fixed Index Annuities and CDs are conservative investments for income-seeking investors.
  • For a shorter time horizon and asset flexibility, a CD is appropriate.
  • For a longer time horizon and continuous income, a Fixed Index Annuity is suitable.
  • Both have benefits and risks that should be understood before choosing the most appropriate option.

In the world of investing, there are an infinite number of options, and this freedom can become overwhelming quite rapidly. Furthermore, the changing economic and political landscape has made the endeavor of learning not only difficult but also filled with uncertainty. According to a survey conducted by Capital One and The Decision Lab, 77% of Americans feel anxious about their financial situation. That’s not a great number! The growing anxiety and need for consistency become even more paramount for investors nearing retirement. So, when it comes to making these tough financial decisions, working towards more certain outcomes can bring resounding peace of mind.

In this article, we are going to discuss two investment vehicles, the Fixed Index Annuity and the Certificate of Deposit (CD), which are not only conservative but also act as crucial income plays in anyone’s portfolio. Inevitably, it comes down to picking the right tool for the job.

Comparing Fixed Annuities and CDs

Firstly, let’s define the terms. A Fixed Index Annuity is a contract issued by an insurance company with the intention of paying out a stream of income over a future period of time. The Fixed Index Annuity invests an initial premium that grows tax-deferred and offers a guaranteed return over an investor’s lifespan. Though there are variables with an annuity vehicle, we will only be focusing on the aforementioned aspects.

Now, a CD also offers income, but the nature of the vehicle is different. A CD is essentially a time deposit where an investor leaves a lump sum of money with a bank in return for a specified interest rate at maturity. The rate of return varies by the amount of principal, length of term and the offering institution.

Low Risk Investments

Arguably, the biggest similarity between the Fixed Index Annuity and the CD is that both investment vehicles are considered low-risk investments. CDs are generally issued by banks and are insured by the Federal Deposit Insurance Corporation (FDIC), a government entity, up to $250,000 per individual. 

A Fixed Index Annuity, though not insured by the U.S. government, is backed by the paying ability of the issuing insurance company. For context, only six insurers licensed to sell annuities have gone into receivership since 2008. Simply put, these companies could not meet their financial obligations and were controlled by a trustee. So, all in all, it’s safe to claim that these investments are both low risk. From here, to understand which product is the most suitable for an investor, we need to break down the differences.

Interest Rates

Fixed Index Annuities derive their interest rates from the performance of a tracked market index. The annuitant is generally offered a “participation rate,” which provides a portion of the yields. This mechanism allows the insurance company to continue making minimum payments even if the index has a negative yield for the year, ensuring consistent payments year after year. Conversely, a CD’s interest rate aligns with the decision-making of the Federal Reserve Board. The CD’s rate generally follows the rise and fall of the federal funds rate – the overnight lending rate that banks charge each other.

Duration, Flexibility and Accessibility

The difference between duration, flexibility and accessibility is where these two products diverge the most. In simplest terms, the Fixed Annuity is a long-term play designed to protect assets for one’s remaining life. The initial premium is put in place for future annuity payments, and any early withdrawal is generally subject to hefty surrender charges. 

Each contract offers a surrender fee chart before any individual invests. By contrast, the CD is more of a short-term play. Granted, there are CDs that can range up to 10 years, but most typically range from three months to five years. 

Furthermore, the investor has the option to withdraw their funds at any time while bearing only minor interest rate penalties, which range from 30 days to six months of interest.

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What is your goal for purchasing an annuity?

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Benefits of a Fixed Indexed Annuity

At this point, we are beginning to see the similarities and differences between the two products, but let’s summarize the benefits of each so we can fully understand which product is best for whom. The Fixed Index Annuity is a tax-deferred vehicle that offers a guaranteed stream of income at a future date. Because the yield is tied to a market index, there are opportunities for higher returns than one would find in a CD. As mentioned before, the money is tax-deferred, so we are pushing tax payments back and capitalizing on compounding interest.

Benefits of a CD

A CD is a time deposit with a bank or credit union that offers interest over time. Due to FDIC insurance, the CD is a safer vehicle compared to a Fixed Index Annuity. It also has more predictable returns and shorter commitment periods – this is the most important difference and biggest advantage.

Drawbacks and Suitability

With any investment vehicle, there are caveats. Typically, where one benefits over another, its drawbacks are the exact opposite. This inevitably leads to proper suitability.

A Fixed Index Annuity is a vehicle beneficial for long-term retirement planning, offering a fixed stream of income for one’s lifespan. Interest rate returns are tied to a market index, potentially providing investors with a sizable portion of the index’s return. However, because this investment is best suited for individuals seeking secured payments over a long period, the drawback is flexibility. Fixed Index Annuities also incur heavy surrender charges if withdrawn too soon. Additionally, these investments come with annual fees and are rather complex.

On the contrary, CDs work differently. They are suitable for someone seeking short-term savings. Individuals needing more flexibility with their money in the short term should turn to CDs for interest in a low-risk environment. However, the drawback is lower returns. Since 2000, CD rates have yielded over 5% in only four years. Subsequently, inflation rates were over 4% year-over-year during that same time frame. This indicates that CDs are not significant inflation beaters, and the realized yield (considering inflation) is slightly above 0%.

Historical Trends in CD and Fixed Index Annuity Returns Compared to Inflation

Let’s delve deeper into the figures mentioned earlier, focusing on a specific example. Attached below are the average 3-month CD rates spanning from 1980 to 2023.

Average 3 Month CD Rates from 1980 - 2023

Source: Organization for Economic Co-operation Development

Additionally, included is the CPI inflation trend over a comparable timeframe.

Source: Bureau of Labor Statistics/Haver Analytics

What becomes evident is that the realized returns for a purchased 3-month CD fall between 0.50% and 1.00%. This aligns with the traditional goal of a CD, which is not to vastly outperform inflation, but rather to offer a safe investment vehicle that can at least keep pace with it.

Moreover, the Fixed Index Annuity provides income at a slightly higher rate. Each Fixed Index annuity includes a minimum principal with potential for growth. According to data from the annuity advanced website, the majority of the available products boast a fixed account rate ranging between 4.00% and 5.00%. Considering the current CPI index stands at 3.36%, investors may realize a return of approximately 1.50%, with additional upside potential.

It’s worth noting that while CDs currently yield similar returns to some fixed-rate annuities, this hasn’t historically been the case. Analysis of realized 12-month CD returns since 2004 reveals a negative real return. This underscores the impact of fluctuating yields influenced by inflation and the Federal Fund Rate on an annual basis.

Is An Annuity Right For You?

Our short quiz provides clarity on whether an annuity is a smart choice for your retirement portfolio.

Which Is Right for You?

When determining the right investment for your needs, understanding the purpose behind the investment is paramount. If an investor is in pursuit of a lifelong stream of income with principal protection, their focus should be directed towards a Fixed Index Annuity. However, they should also be prepared for certain drawbacks such as inflexibility, annual fees and potential surrender charges associated with this investment vehicle.

Conversely, for investors seeking short-term income and valuing the flexibility of their funds, CDs are a suitable option. While CDs may struggle to outpace inflation and incur minor interest penalties if withdrawn prematurely, they offer greater flexibility compared to annuities.

Regardless of the chosen option, both annuities and CDs represent relatively safe investments and can serve as valuable components within any individual’s financial plan. 

Ultimately, the decision hinges on whether one seeks long-term or short-term income. For further guidance on these products, it’s advisable to consult with a knowledgeable advisor to determine the most suitable path forward.

Frequently Asked Questions

Are CDs better than Fixed Annuities?

Each product presents its own set of benefits and drawbacks, and neither is inherently superior to the other. Both CDs and Fixed Index Annuities offer income in a relatively conservative manner compared to other market options.

The key distinction lies in their respective time horizons and flexibility. A CD serves as a flexible, short-term investment, while a Fixed Index Annuity represents a consistent, long-term commitment. Understanding this fundamental difference is key when making investment decisions.

What is the downside to a Fixed Index Annuity?

Due to the contractual nature of a Fixed Index Annuity, it tends to lack liquidity. Additionally, it is relatively complex compared to other investment vehicles and comes with various fees, including upfront fees, annual fees and surrender charges for early withdrawal. Therefore, if an investor anticipates needing flexibility with their assets, a Fixed Index Annuity may not be the most suitable investment vehicle.

Is a CD worth it?

For investors seeking short-term income, a CD can be a prudent choice, offering the advantage of liquidity while generating income. The primary aim of a CD is to match or slightly surpass inflation annually.

However, for those desiring greater asset appreciation, exploring alternative investment options may be more suitable.

Still have questions?

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: June 18, 2024
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