A bank CD or a fixed annuity? When looking for a guaranteed investment most people gravitate to the FDIC insured bank CD. This is especially true when one is nearing retirement age and the need for a safe, secure, high yield investment becomes increasingly important. To assume that this common conservative path is always the correct one can be a grave mistake.
Often the Fixed annuity just makes more sense. It is important to note that I am not talking about the Variable Annuity, from whence annuities have received a bad name. A fixed annuity has many advantages over it’s variable counterpart and certainly over the bank CD.
A fixed annuity is completely safe. The principal in a Fixed Annuity is guaranteed by the insurance company that secures it. Many of these insurance companies have been around for well over a hundred years and are incredibly stable. Even when a penalty is incurred, such as through an early withdrawal, you are guaranteed to receive no less than the amount you paid for the Annuity. A bank CD, on the other hand, is FDIC insured. If the bank fails the FDIC will step in and insure the investors funds up to the legal limit. In the event of fees or penalties the investor could receive less than the amount they invested.
A fixed annuity is tax advantaged, it grows tax deferred. Every year with a bank CD the investor will receive a 1099 and pay taxes on their interest. This is not the case with an annuity. Because of this tax deferral the investment grows much more quickly, and the investor is does not incur taxes for money that they cannot use.
As a result of this tax deferral the actual yield on an annuity cannot be compared to the yield on a CD without considering the tax implications. A fixed annuity will guarantee a rate for anywhere from 1-6 years, generally 1,2,3, and 6 year rate locks. After this the annuity has a guaranteed minimum renewal rate, a base rate that the annuity will never earn less than. Most common is a base rate of 3%. When considering that over the past 6 years CD rates have averaged right at 3% and that the tax-deferred minimum of 3% is equivalent to a taxable yield of around 4% this really is not a bad deal. Very rarely will the annuity renew at the lowest rate anyway, and some Fixed Annuities, like one offered by TransAmerica have a bailout feature. If the rate renews under the bailout rate the investor can pull all of their money out without penalty.
Annuities are also more liquid than CDs, despite their longer terms. An Annuity is a longer term investment, typically 5-7 years. Most annuities allow for a 10-15% percent penalty free withdrawal per year and allow penalty free withdrawals in the event of medical emergencies and upon entering a nursing home. Try a penalty free withdrawal from a CD for those reasons!
Estate planning rounds out the advantages of a Fixed Annuity. Upon investing into the Fixed Annuity a beneficiary is designated. Upon the death of the owner of the annuity the funds pass to the beneficiary without going through the lengthy and costly probate process.
So, are Annuities always preferable to CDs? The answer is no. Before investing into a Fixed Annuity a long conversation with a licensed agent is appropriate. In some cases the bank CD may be a better investment. Most banks now have at least one licensed individual in the banking center that can assess whether a fixed annuity or a CD would be the better investment.