Certificates of deposit (CDs) and annuities are 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 their similarities and differences and 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? Annuity vs. CD
- Payments you receive
With annuities, you get regular payments. That is, a portion of the principal plus earned interest. With CDs, you only get the earned interest. The principal remains untouched until the CD matures.
- Taxation
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. The principal is never taxed on 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 is insured differently
Your money, up to $250,000 in a CD, is insured by the Federal Deposit Insurance Corporation (FDIC). State guaranty associations ensure fixed annuities with varying rules.
- Security
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 will likely get minimum guaranteed payments with reduced 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, you can 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 is possible to earn no interest at all, for example, in a single year.
- Penalties
Be prepared to be penalized if you withdraw 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 penalty. You will incur a penalty with traditional CDs if you pull out your money earlier.
With most annuities, you can withdraw a fraction of your funds without penalty. Usually, up to 10% per year without being 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, choosing an annuity that suits you best is ok. 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 that the risks associated with annuities also come with appealing perks, such as 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 that your insurance broker is registered to sell in your residence.
- Check the strengths and weaknesses of the insurance company before buying any new annuity.
Conclusion
Both annuities and CDs are excellent saving vehicles. Making sure you clearly understand how they differ is crucial when deciding. If you cannot determine which option suits you best, consider talking to an experienced financial advisor. Fortunately, there are many financial advisers today you can consult.