Comparison of Annuity vs Certificate of Deposit (CD)
What Is an Annuity?
An annuity is an agreement between an insurance company and a customer to pay the customer an income stream for a certain amount of time, typically until death. It differs from a retirement savings plan in that an annuity can’t invest or grow a customer’s capital balance. The returns on an annuity would depend on the underlying investments of the insurance company. Most annuities offer two types of income: a guaranteed income for life, or a variable income that can go up or down based on the investment performance of the underlying annuity.
Advantages of an Annuity
Guaranteed Income for Life
When retired, annuities offer guaranteed income during retirement years when there are no earnings like before. With the low interest rates in recent years, it has become difficult to get an 8% return on investments which was once easily achievable.
No Required Minimum Distribution (RMD) After Age 70 ½
Unlike 401(k) and IRA accounts, you will not be required to make withdrawals from your annuity account after reaching the age of 70½ that might push you into higher tax brackets if not done systematically. However, you are free to withdraw funds at any time but this will reduce your overall account value and might not be in your best interest to withdraw early.
An annuity can offer additional bonuses which will increase the payout on an existing income stream. These bonuses are typically offered during retirement years when you are looking for more income or if you are purchasing an annuity within a set age limit, say 65 years old, then that would be counted as well.
Favorable Tax Treatment on Some Types of Annuities
Contributions made to an annuity are considered tax-deferred. This means that the money you contribute is not taxed until you start withdrawing it, which can be years or even decades after you make the contribution.
What Is a CD?
A CD, or Certificate of Deposit, is a type of savings account offered by banks and credit unions. CDs typically offer a higher interest rate than a regular savings account, but there are penalties for withdrawing your money before the CD matures. CDs are among the most conservative investments available and are often recommended for people who don’t want to risk their money. The rates for a CD largely depend on the financial institution you’re working with, how much money you are investing in the CD, and the length of time until it matures. When a CD matures, you will get the entirety of the principal plus the interest that it has accrued. Also, you can either withdraw your money or reinvest it in a new CD.
Advantages of a CD
Higher Interest Rates
CDs typically offer a higher interest rate than a regular savings account, but there are penalties for withdrawing your money before the CD matures.
CDs Are Liquid and Easy to Use
Since CDs are offered by banks, they’re very liquid and easy to use. You can access your money whenever you need to although it will come with penalties if withdrawal is done before the maturity of the CD.
Protect Against Inflation
A CD can be ideal for conservative retirement planning because its principal and interest payments typically stay ahead of inflation.
Availability of Funds
A CD offers simple liquidity compared to the complexities surrounding withdrawals from an annuity plan. If there is an emergency situation after investing in an annuity, withdrawing some funds may result in surrender charges while in the case of CDs, only early withdrawal penalties are applicable.
Similarities of Annuities and CDs
Both annuities and CDs are relatively conservative investments, meaning that they carry a lower risk than other investment options. Both annuities and CDs offer a guaranteed return on investment, although the return for CDs is usually higher. Both annuities and CDs allow you to access your money whenever you need it, although there are penalties for withdrawing your money from a CD before it matures.
Differences Between Annuities and CDs
Annuities offer a number of extras, such as bonuses, that CDs do not. Annuities have tax-deferred status, meaning that you don’t have to pay taxes on the money you contribute until you start withdrawing it. With a CD, your contributions are taxed just like any other income. CDs offer a higher interest rate than annuities, but annuities come with a number of guarantees that CDs do not. Annuities are generally more complex than CDs and require more trading activity or maintenance.
Which Is Better Between the Two?
Ultimately, the decision between an annuity and a CD depends on your specific financial situation and goals. If you’re looking for a relatively safe investment with a higher return than a regular savings account, a CD might be right for you. If you’re looking for something that offers guaranteed returns, additional features like bonuses, and tax-deferred status, an annuity might be better. To choose which is better really depends on what your needs are in order to help you determine which investment would best suit your financial goals.
An annuity may not always seem like the ideal choice between it and a CD when interest rates are low, but since future returns cannot be predicted, it’s important to consider all of the available options when choosing an investment. A financial advisor can help you decide whether an annuity or a CD is right for you.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.