Last Updated: January 2021
If you believe you already have enough money set aside to live well into your 80’s or even 90’s, likely, you have already put together a robust financial plan and know how you are going to reach your goals. Unfortunately, most individuals do not fall into this category and need some additional guidance to get started.
Annuities and CDs are two common options individuals can invest in to help safeguard retirement funds while earning some interest. However, annuities and CDs are different in several ways, and it is essential to understand the benefits and drawbacks of each.
In this article, we will cover:
- Overview of Fixed Annuities
- The Main Differences Between CDs & Annuities
- How Annuities Compare to CDs as Investments
- Deciding Whether Annuities or CDs are Best for You
An Overview of Fixed Annuities
For the sake of comparing annuities vs CDs, we will stick with discussing fixed annuities.
Fixed income annuities are the most common form of annuities that have several characteristics that are similar to a CD (more on this later).
Fixed annuities are essentially a contract between you and the insurance company you choose to work with. The primary objective of an annuity is to save income towards retirement.
Annuities Can Stream Income
Annuities are also highly beneficial due to their ability to stream income, which can be critical for seniors needing to budget lump sums of cash to retire comfortably. Annuities allow you to begin payments immediately or defer the earnings until a later specified date in time. During this deferment period, taxes are also deferred.
- Fixed annuities can offer a fixed interest rate that is locked in for a pre-determined length of time that most commonly will range from 3-10 years.
- In most situations, the longer you choose to lock your money in an annuity, the better-fixed interest rates you can receive.
Choose Your Own Payout Phase With Annuities
When structuring an annuity, you are also capable of structuring your payout phase. This simply means you will be able to select the duration you need the money streaming. Of course, this will vary based on the kind of annuity you purchase.
Some individuals will choose to receive payments for life at lower amounts, and some will have what is known as a “period certain,” which will stream the payments to you for a locked-in number of years such as 10, 15, or 20 years.
The Main Differences Between CDs & Annuities
CDs are like annuities but do have some significant differences.
- CDs are provided by banks and are FDIC insured, instead of being offered by insurance companies.
- CDs are not meant to be a long term investment and are designed to earn some interest for the short term. Although it is possible to purchase a CD that can have a fixed interest locked in for up to 10 years.
- In most situations, an annuity is going to be capable of providing a higher interest rate on your investment if you are in between a locked-in period of 3-10 years.
- CDs have a low rate of return but are a safe investment that is meant to be collected and reinvested in shorter intervals than annuities.
Now, let’s stack up the annuity vs. the CD to give you a clearer picture of the differences.
How Annuities Compare to CDs as Investments
Annuities and CDs have some differences in their payout structure, taxes, and liquidity.
Annuities Have a More Frequent Payout Structure Than CDs
Annuities allow for you to collect your payments in intervals such as monthly, quarterly, annually, or semi-annually with interest and principal.
CDs only allow for payouts at the end of maturity date with both interest and principal at the same time.
Tax Differences Between Annuities and CDs
With annuities, you are going to defer your taxes until you begin taking your stream of income. At this time, portions of your principal and interest earned are going to be taxed as regular income taxes.
With CDs, the principal is never going to be taxed, and your interest income will be taxed as regular income.
Liquidity and Surrender Periods for Annuities & CDs
Annuities are not typically designed for individuals needing liquidity. On the other hand, CDs can be purchased in durations that make them much easier to convert to a lump sum of cash if necessary.
While the earning potential may be slightly lower with CDs, the option to get your money is a nice relief in case an emergency arises.
Do not forget that annuities have a surrender period in which could cost you 10% if you happen to need to cash out your annuity before the payout period, which is designed for beginning at age 59.
Deciding Whether Annuities or CDs are Best for You
When making your decision on if an annuity or a CD is best for you, the first consideration should be how liquid you need the funds to remain. This should be a consideration that is discussed and analyzed before any investment.
Due to a CD only needing 6 months to mature in some cases, although you can choose longer, it makes them much more viable for individuals who do not like the idea of the money being locked away or facing surrender charges.
Annuities are Helpful as Investments and Retirement Savings
For long term investors where the money being invested is earmarked for nothing more than investing and retirement savings, annuities are safe when compared to many other options.
Annuities should also be your front runner if you are in need of your lump sum cash being distributed to you on a monthly basis to help cover ongoing expenses.
Beginning the Process in Securing Your Investments
When you begin searching for the correct investment for you, you should be working with a licensed professional who has access to offer you several different options, including annuities and CDs.
Also, make sure your advisor can help you shop interest rates with multiple providers.
Annuity rates are always changing and depending on the length of time you can invest; you can likely find a higher interest rate than you believe possible by shopping your options.
At the end of the day, talking with a licensed professional and evaluating all your options is the best approach you can take. Ultimately, it is going to be the best way to ensure you are investing in the highest performing annuities or CDs.