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The Difference Between a CD &
a Fixed Annuity
(By eHow
Contributing Writer)
Certificate of
Deposits (CDs) are issued by banks, and annuities are issued by
insurance companies. Understanding some differences may help you decide
which one is best for you.
What is a CD?
- CDs are issued by banks and
offer investors a safe place to invest their money. CDs grow based
on a stated interest rate by the issuing bank over a predetermined
time frame, such as three months, six months or one year. CDs are
not based on the stock market or any other volatile index. Once the
CD reaches the end of its period, the bank will automatically roll
the CD over into a new period at a rate the bank is paying
currently. The interest rate is only guaranteed for the duration of
the CD period and can and will change. The periods can also range up
to five years depending on the bank issuing the CD. Typically, the
longer the duration of the CD period, the higher the interest rate
the bank will pay.
What is a Fixed Annuity?
- Fixed annuities earn interest
much like a CD does, but usually only on an annual basis on the
policy anniversary. Fixed annuities are issued by insurance
companies, and they earn an interest rate stated each year by the
insurance company. Like a CD, fixed annuities are safe investments
and not based on the stock market or any other volatile index.
Insurance companies also offer multiyear guarantees on an interest
rate. For example, an insurance company may offer a guaranteed 5
percent interest rate for the first five years. When this time
period is up, the insurance company then has a right to drop the
rate down to a minimum guarantee allowed by the state it is
operating in, such as 1 percent or 1.5 percent.
What are the Differences?
- There are many similarities
when it comes to CDs and fixed annuities, but there are also
differences. One of the main differences is the fact that fixed
annuities offer tax-deferred growth of your money. With a CD, the
bank will send the owner a 1099 form at the end of the year listing
the amount of interest earned. This amount must be included on the
owner's tax return and is subject to ordinary income tax. A fixed
annuity, however, grows tax deferred, meaning there is no tax
reporting of interest year by year. The tax is paid by the owner
when he or she withdraws from the annuity, so the owner is
capitalizing on triple compounding--interest on principal, interest
on interest and interest on money that would've been paid in taxes.
Fixed annuities also may carry a declining surrender charge schedule
and have some different liquidity features than CDs. Typically, the
insurance company will allow the owner to withdraw up to 10 percent
of the value of the annuity each year without having to pay any
surrender charges. If the owner withdraws more than 10 percent, the
insurance company may impose a surrender charge. This amount
decreases each year until it reaches zero. Annuities also are
considered retirement accounts and are subject to a 10 percent
penalty if the owner withdraws any amount prior to the age of 59
1/2.
What are the Real Guarantees?
- CDs and fixed annuities both
have guarantees backed up by the government. CDs fall under Federal
Deposit Insurance Corporation (FDIC) insurance. In the past, the
amount that was insured in banks was $100,000, but that recently was
changed by the federal government to $250,000 until December 31,
2013, in light of the recent economic turmoil experienced in this
country. Annuities are not backed up by the FDIC but instead by each
state's guarantee funds that help pay claims for financially
impaired insurance companies. This amount varies by state.
Which One is Best for Me?
- Choosing between CDs and fixed
annuities depends on a number of factors: your age, your tax
situation and your investment objectives. Consult a financial
professional who can help you assess your situation and make
recommendations based on your objectives, risk tolerance and tax
status. Read all prospectuses and make sure you completely
understand what financial product you are buying before investing
any money. Following these guidelines should help you eliminate any
surprises or financial mistakes.
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