The pros and cons of a CD vs. a Fixed Annuity
We have many clients that come to us wanting to make a limited-term investment that is safe, and they ask us if they should be investing in a CD or a Fixed Annuity. Both of these types of investments are considered safe. The federal government backs CD’s, and the issuing insurance companies back Annuities. We recommend only investing with insurance companies that have a high AM Best, Moody’s, Standard & Poor’s, or Fitch rating. With CDs and Annuities, money is invested for a specific amount of time, and then a payout of the principal and interest accrued is made. This is about where the similarities end. The two differ in a few key ways, and in most cases, a Fixed Annuity ends up on top.
Returns
Most important to our clients is usually the returns they are going to receive. It is best to compare apples to apples, so we will look at a 5 Year fixed Annuity versus a 5 Year CD.
Annuity: As of August 2020 the 5 Year Fixed Annuity is returning a rate of 3.1% per anum. For every $100, you will be receiving a return of $3.10/year in interest.
CD’s: As of August 2020 on bestcashcow . com for our locale of Michigan market, we find that banks are providing CDs that are giving returns of between 1.1% and 1.4% per anum. This requires a deposit of $10,000 to obtain these returns. For every $100 you will be receiving at best $1.40/year in interest.
Assuming the best case, you are still making more than double the return of a CD with an Annuity.
Taxes
Earnings on CDs are taxed when the interest is earned, even if not withdrawn.
Fixed annuities earnings are tax-deferred and not considered taxable income until they are withdrawn. This gives control for the payment timing of taxes. When saving over the long term, it makes good investment sense to rely on tax deferrals.
Depending on other income Social Security benefits may also not be taxed with Annuities. Taxable income may be reduced with an annuity to the point where taxes on Social Security benefits are not owed. However, a CDs’ interest is taxable when earned, adding to income which includes Social Security benefits,even if CD earnings are not withdrawn they count as taxable income. Depending on a tax bracket, up to 85% of Social Security benefits could end up subject to taxation.
Probate
Because an annuity is considered insurance, an Annuity’s account value will be paid directly to a named beneficiary(ies), avoiding probate costs and delays. CDs may be subject to probate. It should be noted that both are subject to estate tax, and that the earnings inside a fixed annuity are subject to income tax when paid out (the earnings of a CD, by contrast, again are taxed when earned).
Liquidity
With a CD, if money is needed before the maturity date, it may be penalized between 30 days to 6 months’ interest.
With Annuities, a withdrawal made within the first several years may be subject to a “surrender charge”. Most companies give the flexibility to withdraw a portion of the account value (i.e. 10% each year), without a surrender charge. After the surrender charge period expires, funds can generally be accessed at any time without surrender penalties. Note that such withdrawals may be taxable and, before age 59½, may suffer a 10% penalty tax.
Options
At its maturity, you can take the CD’s lump-sum value in cash, renew for the same or a different maturity period, or roll it into another asset like an annuity. With an Annuity, money can be withdrawn as a lump sum or one of several other options, including a lifetime income option that can not be outlived, or letting the funds continue to accumulate until a need arises, allowing for continued tax deferment.
Summary
For most, a Fixed Annuity’s benefits out way any benefits that a CD provides. The returns, tax deferment, options, and liquidity make them a better investment for the majority of our clients. If you have any questions, would like to roll over a CD you currently own or wish to set up a new fixed annuity, please feel free to find more info or contact us HERE.
