Certificates of deposit (CDs) and annuities are both excellent saving vehicles that help you save enough money for retirement. Having your money in them guarantees you a sufficient income stream in retirement.
While both are worth your attention, knowing the similarities and differences between them plus their pros and cons can help you decide which suits you best. This piece helps you to make the right decision by comparing these two saving vehicles.
What is the difference?
Payments you receive
With annuities, you get regular payments. That is, a portion of principal plus earned interest. With CDs, you only get the earned interest. The principal remains untouched until the CD matures.
While interest from both CDs and annuities are taxed as regular income, with annuities, principal and interest are taxed as regular income. You are taxed when you make a withdrawal. Principal in never taxed in CDs.
Note that a section of payments from annuities bought with after-tax money is taxed as regular income, and a portion is not taxed.
Your money insured differently
Your money, up to $250,000 in a CD, is insured by the Federal Deposit Insurance Corporation (FDIC). Fixed annuities are insured by state guaranty associations, with varying rules.
You are guaranteed to receive principal investment plus a specific amount of interest when you invest in CDS or annuities. What varies is the insuring entity. With CDs, up to $250,000 is insured through the National Credit Union Share Insurance Fund or the Federal Deposit Insurance Corp.
Fixed annuities are insured by insurance companies, some of which are not financially stable. In the event an insurer goes bankrupt, another may step in. In such a case, you are likely to get minimum guaranteed payments with reduce interest rates. To avoid such a scenario, consider researching the insurer’s financial wellness before reaching a decision.
With fixed-indexed annuities, your principal investment is protected. Plus, there is an opportunity to earn more interest than you would through a standard fixed annuity. But since returns are based on the performance of market indexes like the S&P 500, it possible to earn no interest at all, for example, in a single year.
Be prepared to be slapped with penalties if your withdrawal your money before the term ends in both annuities and CDs. However, there is an exception if you opt for no-penalty CDs as they allow you to withdraw your money earlier without incurring a penalty. With traditional CDs, you will incur a penalty if you pull out your money earlier.
With most annuities, you are permitted to withdraw a fraction of your funds without incurring any penalty. Usually up to 10% per year without been slapped with a penalty. For fixed annuities, be prepared to incur a penalty if you pull out your money before the end of the term.
Which is the right option?
Identifying your saving goals make reaching a decision an easy task. So, you may want to take your time and clearly understand your goals.
If saving for a long-term goal such as retirement, it is ok to choose an annuity that suits you best. Make sure to choose an annuity with favorable terms. But if uncomfortable with the risks of annuities or saving for a shorter-term goal, consider choosing a CD.
It is good to note the risks associates with annuities also come with appealing perks, for example, a higher and guaranteed income.
Here is how to mitigate the risks associated with annuities:
- Deal with a registered broker. Make sure to check with the state insurance commission to confirm your insurance broker is registered to sell in your state of residence.
- Check the strengths and weaknesses of the insurance company before buying any new annuity.
Both annuities and CDs are excellent saving vehicles. Making sure you clearly understand how they differ from each other is a crucial step when deciding. If you find yourself unable to determine which option suits you best, consider talking to an experienced financial advisor. Fortunately, there are many financial advisers today you can consult.