When you are looking for safe investments, both certificates of deposit and annuities may be on your shopping list. Although the two are similar because of their security and guaranteed rate of return, there are also differences that set them apart. An annuity versus certificate of deposit comparison will help you choose the investment that best fits your needs.
Investors purchase a certificate of deposit from a financial institution as a safe, low-return investment. CDs are time deposits with fixed interest rates and set terms, usually ranging from a few months to five years. Interest rates for CDs are guaranteed and they are somewhat higher than rates on a money market account, but significantly lower than other types of investments due to the short-term nature of the investment. If a CD is redeemed prior to the specified term, the investor sacrifices interest but does not lose principal, or the initial investment. Investors purchase an annuity from an insurance company as a safe, long-term investment. An annuity is essentially a type of insurance offering the investor a series of annual payments (thus the name). Investors preparing for retirement often choose annuities because they can produce a reliable income with a guaranteed minimum interest over a long period of time.
Financial institutions issue CDs, so CDs have a guarantee against banking failure of up to $250,000 from the Federal Deposit Insurance Corporation. Insurance companies issue annuities, so they do not have the same FDIC guarantees as CDs. However, annuities offer the safety of the reserve of the issuing insurance company. Insurance companies often receive a rating that indicates their financial strength. Investors can check this financial rating prior to choosing an insurance company.
Short Vs. Long Term
CDs provide earnings based on short-term maturity periods. These periods generally span five years, but they may be as short as one month. Conversely, investors with a longer time frame for investing might choose annuities instead due to the tax deferral benefits.
CDs and annuities incur vastly different tax burdens on earnings. Money earned from CDs is subject to taxation as it accumulates, even when you leave the money in the account. Annuities earn money tax-deferred until you withdraw it. Furthermore, CD earnings count as provisional income for determining taxes on Social Security benefits. Annuity earnings do not become a part of provisional income and will not affect your Social Security benefits.
CDs have a guaranteed interest rate valid for the course of the CD. Shorter term CDs usually have lower interest rates than longer term CDs. Annuities have a locked interest rate for a specified initial period with a minimum interest rate guaranteed for the life of the annuity. After the initial period elapses, interest rates adjust automatically according to current economic conditions.
At maturity, you have two options with a CD. You can renew it for a similar length of time or you can remove all the funds as a lump sum. CDs held at the time of your death become a part of your estate. With an annuity, you have more options. You can remove all funds, similar to a CD. You can also remove only a portion of the funds to use them in an ongoing fashion. A third alternative is to simply leave the funds untouched in the annuity and allow them to continue to earn interest. If the annuity has funds at the time of your death, the monies pass to a designated beneficiary.
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