What are the differences in a CD and a fixed annuity?

Certificates of deposits (CDs) and fixed annuities have many similarities and differences. Choosing which one best suits your needs will depend on your financial goals and personal preferences. CDs and fixed annuities are similar in the aspect they both provide steady returns and offer the investor predictable income. Both CDs and fixed annuities are free from market risk, and there is no risk of losing the principal amount invested.  The information below explores some key differences in CDs and fixed annuities.

​

Term

CDs are available with terms that range from days to multi-year periods depending on the bank or credit union where your CD is issued.  Once the term has been met, the CD may be cashed in or rolled over into a new contract. If the CD is rolled over, the interest the account earns may fall or rise depending on market conditions. Typically, a CD with a longer term will have a higher interest rate compared to a short-term CD because of the increased opportunity cost associated with holding the investment for an extended period of time.

​

Fixed annuities, which are sold by insurance companies, typically have a contract ranging from 5-7 years. Money can be invested in a lump sum, or in multiple payments depending on the terms of your contract. During the lifetime of your contract you are guaranteed a certain interest rate.  If you choose to extend your contract, the funds will be re-invested at a newly determined rate. Interest on these annuities is also triple compounded. Investor’s will earn interest on principal, interest on the taxes, and interest on interest.

Taxes

Interest that is earned from a CD is considered taxable income, which may result in some or more of your monthly Social Security payments becoming taxable. However, there is an exception. If the investor chooses to place their CD in a retirement account, like an IRA, the CD will grow tax-deferred.

​

Non-qualified money invested in a fixed annuity will grow while being tax-deferred. This means the investor will be not be taxed on the interest that is accumulated unless a withdrawal is taken. Should you decide to take money out of the annuity you will be taxed on the interest only, not your original premium. The interest on the account is taxed at the regular income tax rate, regardless of the consumer’s age. If you choose to cash in your tax contract before the age of 59 ½, you will incur a 10% tax penalty. 

​

Withdrawals & Penalties

Withdrawing from your CD prior to the term being satisfied will result in an early withdrawal penalty in most types of CDs. These penalties are set by the bank or credit union where the CD is issued, and is also determined by the CDs term.  It is also worth noting that if the investor of the CD has passed, and the spouse would like to withdrawal from the account, they will be penalized. 

​

Fixed annuities offer you the ability to access your money after a set period of time as outlined in the insurance company’s contract.  You will incur an interest penalty on withdrawals made prematurely, however in some cases the investor can withdraw from the principal without having to pay a fee. In cases of death, the spouse will usually have complete access to the funds without incurring a penalty.

​

Exemptions

CDs must go through a probate process in the event of death, prior to reaching beneficiaries. The only exception is if the inheritor(s) is placed in a living or irrevocable trust.  In addition, CDs are classified as “non-exempt.” This means the funds can be garnished as a result of a lawsuit or through a creditor.

​

With fixed annuities, a beneficiary is named in the event of death, therefore avoiding the probate process. Also, dependent on the state in which you reside, annuities can be exempt from lawsuit claims.

 

The information above examines just a handful of key similarities and differences between certificates of deposits and fixed annuities. Your financial goals and personal preference will determine which financial outlet best suits you. The financial advisors at The Irwin Agency can provide guidance in choosing which financial services are best for you. Consultations are at no charge to you, and you can book yours today by contacting us via our online submission form, or by calling (501) 623-7066.