Link to the Show / Show NotesCD versus Deferred Annuity Comparison Safety, Return, and Investment Time
Retirees with cash often seek an investment with a lot of safety. Holding a certificate of deposit (CD) gives you that safety but sacrifices investment return. Let's compare a CD to a deferred fixed annuity for safety, return and investment time. Then you can choose what's best for you.
The Safety Issue
Banks offer CDs. The Federal Deposit Insurance Company (FDIC) guarantees any investment in a bank up to $250,000 (through 2009) against the bank's failure. If you plan to invest more than that, spread it between different banks – not different accounts in the same bank – so all your holdings are FDIC guaranteed. Bank failures are not all that uncommon.
A deferred fixed annuity hasn't any FDIC protection. But it's still considered a conservative investment. First it's backed by the financial strength of the company that issues the annuity. So, before buying a deferred fixed annuity, check the insurance company's financial rating. Independent rating companies such as Moody's, A.M. Best, Standard & Poor's and Fitch provide this information to you.
As a safety backup in case of failure, many insurance companies are affiliated with a guaranty association in their state. One example is the Georgia Life and Health Insurance Guaranty Association in Georgia. It provides total annuity cash surrender protection per owner per insurance company of $100,000 (read these guaranty association terms carefully—some state that the guarantee is conditional on the association having funds).
The Return Issue
Your return for CDs and deferred fixed annuities depend on their interest rate earnings and taxation. CDs offer guaranteed interest rate for a fixed term – generally, the shorter the term, the lower the rate. All CD earnings are taxed annually – whether you withdraw money or not. This yearly taxation loss reduces the annual compounding of a CD's return.
A deferred fixed annuity can guarantee an interest rate for an initial period or for multiple years. But earnings of annuities are tax-deferred. So at equal interest rates, your savings will compound annually faster than for a CD. Annuity earnings are taxed only when you withdraw them.
The Investment Time Issue
Withdrawing money before term for a CD will bring a penalty. And an early surrender from a deferred annuity will do so too. So if you're planning on using most of that money within a year or two, then a CD is probably the better choice. But if you plan on holding for the long term a deferred fixed annuity may be more advantageous.
Refer to the table for a quick summary of comparison issues. You just need the current interest rates and early withdrawal penalty features of CDs and deferred annuities to make an informed decision.
Comparing issues for CDs and Deferred Fixed Annuities
Issue
CD
Deferred Fixed Annuity
Held by
Bank
Insurance Company
Safety
If Bank Failure then FDIC up to $250,000 per bank
Backed by financial strength of Company (see ratings at A.M. Best or Std & Poor's, Fitch)
Also if Company failure Guaranty Association up to $100,000 per company
Interest earned
Offers guaranteed rate for fixed period
Shorter period - lower rates
Guaranteed rate locked ion for initial period
Often offered guaranteed minimum interest rate
Taxation
Earnings taxed yearly so reduced annual compounding of return
Tax on earnings deferred until you withdraw money so earnings compound faster
Time to invest
CD is best if need money within 1 year
Deferred Annuity if several years and longer
Note on Annuities: With tax deferred investments, income taxes may be due upon withdrawal of funds, withdrawals prior to age 59½ are subject to a 10% penalty. Annuities have surrender charges or expenses associated with them while CDs have early withdrawal penalties. The purchase of annuities may incur commission and annuities may not be as liquid as CDs. CDs are FDIC insured to $250,000 per owner while annuities are not and are guaranteed by the claims paying ability of the insurance company.
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