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Understanding Fixed Annuities and CDs

Retirement Funding

Understanding Fixed Annuities and CDs

Fixed annuities and Certificates of Deposit (CDs) are both popular investment vehicles, especially among those seeking low-risk options to preserve capital and generate steady returns. A fixed annuity is a financial product offered by insurance companies that provides a guaranteed rate of return and a series of future payments. It can be tailored to provide income over a specified period or for the rest of the annuitant’s life, making it particularly useful for retirement planning. On the other hand, a CD is a savings product offered by banks and credit unions that provides a fixed interest rate over a set term, typically ranging from a few months to several years. CDs are known for their safety and simplicity, with the added benefit of FDIC insurance up to $250,000 per depositor, per bank. While both serve the purpose of safe investment with predictable returns, they cater to different financial needs and horizons.

Similarities

Principal Protection: Both fixed annuities and CDs ensure that the principal investment is safeguarded.

Fixed Interest Rates: Both offer a guaranteed interest rate for a set period, providing predictability.

Low Risk: Both are low-risk options compared to more volatile investments (like stocks).

Differences

Issuer

CDs: Issued by banks and credit unions.

Fixed Annuities: Issued by insurance companies.

Insurance and Guarantees

CDs: FDIC insured up to $250,000 per depositor, per bank, offering strong protection.

Fixed Annuities: Not FDIC insured, but backed by the issuing insurance company. State guaranty associations provide some protection, though it varies by state.

Interest Rates

CDs: Typically offer lower interest rates

Fixed Annuities: Often provide higher interest rates

Taxation

CDs: Interest is taxed annually as ordinary income, impacting your annual tax bill.

Fixed Annuities: Interest grows tax-deferred until payments are received or a withdrawal is made, potentially lowering current tax burden and aiding in long-term planning.

Liquidity

CDs: Have fixed terms and charge penalties for early withdrawal, but terms are relatively short, allowing access to funds at known intervals.

Fixed Annuities: Typically have longer terms and may impose substantial surrender fees for early withdrawal, making them less liquid but more suitable for long-term commitments.

Payout Options

CDs: At maturity, the principal and interest is received, with no structured payout options.

Fixed Annuities: Offer various payout options, including lifetime income.

Purpose and Use Case

CDs: Ideal for short- to medium-term savings goals and when liquidity is needed at a known date.

Fixed Annuities: Better for long-term retirement planning and ensuring a steady income stream.

When Fixed Annuities Might Be a Good Replacement for CDs

    • Long-Term Goals: If the focus is on long-term growth, particularly for retirement, fixed annuities’ higher interest rates and tax-deferred growth are appealing.
    • Income in Retirement: For a reliable income stream in retirement, fixed annuities’ structured payout options provide peace of mind that CDs cannot.
    • Tax Deferral: Being in a high tax bracket now, understand that fixed annuities offer tax-deferred growth, allowing me to defer taxes until I’m in a potentially lower tax bracket in retirement.

When CDs Might Be Preferable

    • Short-Term Liquidity: If access to funds are needed in the near term, CDs offer more flexibility and shorter terms.
    • FDIC Insurance: CDs provide a level of government-backed protection that fixed annuities do not.

In summary, fixed annuities can be a valuable replacement for CDs if the primary goals are long-term growth, retirement income, and tax deferral. However, for short-term savings and liquidity needs, CDs might be more appropriate.

Advisory services are offered through Investors Portfolio Services, a SEC Investment Advisor. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. All information and ideas should be discussed in detail with your individual adviser prior to implementation.

Investopedia - CDs vs. Annuities