Bank certificates of deposit and fixed deferred annuities often compete for the same savings dollars. Both offer guaranteed principal values and fixed rates of interest. The choice between an annuity and a CD will boil down to the offered yields, the desired level of safety and tax consequences.
Bank CDs are covered by government-provided FDIC insurance for accounts up to $250,000. The FDIC insurance is a major selling feature for banks, taking them off the hook to protect customer account values. The primary safety factor behind a fixed annuity is the life insurance company issuing the contract. Insurance companies are rated by several agencies, making it possible to evaluate and compare the stability of the company behind any annuity. There are also state guarantee associations to help with insurance policies -- including annuities -- sold by companies in financial trouble.
Interest Rates and Penalties
Often the primary appeal of a fixed annuity is the higher offered yield than you can get on a CD. A fixed annuity usually pays a rate that is guaranteed for a period of years ranging from 2 to 7 years or longer. When the guarantee period runs out, the insurance company will continue to pay a rate based on the company's investment results. A CD has a fixed rate for a fixed term from 90 days out to 5 years. At the end of the term, a CD can be rolled into another certificate of your choosing. CDs have interest penalties for early withdrawals. An annuity will typically have a surrender charge for a period of years, with a surrender fee percentage that declines each year until it vanishes.
Tax Benefits and Penalties
Interest earned on a CD is reported each year and taxes must be paid. The interest earned on a deferred annuity grows tax-deferred until withdrawals are made. Annuities are intended as retirement savings products so there is an additional 10 percent tax penalty on earnings withdrawn before age 59 1/2. For savers in their late 50s or older, the tax-deferral of annuity earnings can be a powerful tool for income tax planning.
Other Annuity Products
While a fixed deferred annuity provides a close but different alternative to a bank CD, other annuity products offer different features or earnings potential. Deferred variable and equity indexed annuities provide returns based on the stock and bond returns, but with significantly higher levels of restrictions and complexity. An immediate annuity is a guaranteed stream of income. This income option is one way to draw from a deferred annuity and cannot be duplicated by other savings or investment product types.
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