Evaluating CDs vs. Annuities
When it comes to CDs (certificate of deposits) and annuities, many people are confused by the differences and may not understand which one is a better vehicle. Both are considered safe and secure, offer guaranteed return rates, and are offered by large financial institutions: CDs by banks and annuities by insurance companies. But each option has its own nuances and not understanding the differences could significantly alter your portfolio’s performance... Let's see how these stack up against each other.
- Protection for your funds. The Federal Deposit Insurance Company (FDIC) insures FDIC-member bank-issued CDs for up to $250,000 (principal and interest) per depositor, per bank, in the event of a bank failure. Annuities do not offer the same insurance protection. If you’re considering an annuity, check out the insurance company’s rating with an independent rating firm such as A.M. Best Company.
- Rates of Returns. CDs are short-term investments that pay fixed interest rates for the term of the CD but are subject to fluctuating rollover rates and early withdrawal penalties. A fixed-rate annuity, on the other hand, typically offers a minimum guaranteed return rate. Your annuity contract specifies the minimum return rate, so even if interest rates drop, your investment will retain the contracted return rate.
- Tax treatment. With a CD you will pay taxes on any interest you earn during the term but you cannot withdraw money from the CD until the term ends without suffering financial penalties. While an annuity also has a set term, earned interest is tax-deferred, allowing your cash value to grow at a faster rate. You pay taxes only on any interest the annuity earns after you start withdrawing income from it.
- Access to your fund. As noted above, you cannot withdraw money from a CD until the term is over without facing substantial early withdrawal penalties. Annuities, on the other hand, have a built-in provision that allows you to withdraw a portion of your money every year, often about 10% of the account value. Many allow you to withdraw any interest earned each month. There are other contract provisions that enable you to access everything in the annuity if you are hospitalized, have a life-threatening illness, are subject to a permanent stay inside a nursing home, or suffer a major calamity that could affect you economically. You can also structure an annuity to pay out over a fixed term, which helps spread out any tax burden and provides an enhanced level of income security.
What's Best For You?
As with any financial product, there is no winner or loser; what’s best for you depends on your investment strategy, risk-reward comfort level, and the features you find most valuable. Need help sorting out your options? Let your professional advisor work with you to develop and prioritize your goals and identify the best investment options for you.