In today’s low interest rate environment, many conservative investors are finding it hard to identify investment options that are attractive yet safe. Two popular options are certificates of deposit (CDs) and fixed deferred annuities. Both are considered low-risk vehicles for building wealth; yet they differ in important ways.
Which choice is better? The answer depends on your goals and priorities. The following information will help you determine which of these two products is best suited for your needs at this time.
- Safety of Principal: Both CDs and fixed deferred annuities are considered low-risk investments. CDs are generally issued by banks and, in most cases, are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor. Should the bank fail, the FDIC guarantees CDs up to this amount.
Fixed deferred annuities are issued by insurance companies and are not insured by the U.S. government. They are backed by the financial strength of the issuing insurance company, regardless of the amount. Therefore, before purchasing an annuity, you should make sure the issuing insurance company is financially sound. You can determine financial strength by requesting the findings of independent rating companies such as Moody's, A.M. Best, Standard & Poor's and Fitch. These companies evaluate the financial strength of insurance companies and publish ratings that give their assessments of each company.
- Short Term vs. Long: If you're saving toward a specific near-term objective — say a down payment on a car or home — a CD may be the way to go. CDs offer a guaranteed interest rate over a maturity period that could range from a month to a few years.
Fixed deferred annuities, also offer a guaranteed interest rate over a period of time that could range from 1 to 8 years, but they are generally designed for accumulating or protecting assets for retirement. They can also offer flexibility if you need to access your money, however, there may be charges, taxes or IRS penalties if you withdraw your money too soon. Fixed deferred annuities can even be used to provide a legacy for your heirs.
- Distribution Options: When a CD reaches its maturity, you can take the CD's lump sum value in cash, renew the CD for the same or different maturity period or examine other investment alternatives (such as a fixed deferred annuity).
After the surrender period on a fixed deferred annuity (the amount of time an investor must wait until he or she can withdraw funds from an annuity without facing a penalty), you may elect to withdraw your money in a lump sum or you may want to select a lifetime income option. The lifetime income option provides you with a flow of income that you cannot outlive. You can also elect to let your funds continue to accumulate until a need arises.
- Taxes: Federal law treats these two savings options quite differently. If taxes are a concern, a fixed deferred annuity may be the more attractive choice. CD earnings are taxable the year the interest is earned, even if you don’t withdraw the money at that time. In contrast, earnings from fixed deferred annuities are not taxed until they’re withdrawn, giving you some control over when and how much tax you'll pay. For specific tax advice, you should consult your tax professional or advisor.