Fixed Annuity vs CD Certificates of Deposit (CD’s), offered by banks, are the most popular savings vehicle outside of savings accounts. Fixed annuities, available only through insurance companies, are rapidly gaining in popularity. People want to be certain that their money is safe, working for them as hard as possible, and accessible. In considering the benefits and features of fixed annuities vs. CD’s, which is a better investment, in terms of safety, profitability and accessibility?

Safety

CD’s are insured by the FDIC; thus, if the issuing bank fails, the FDIC will make good on the CD up to the current limit for individual deposits ($250,000); however, it will stick to the strict terms of the CD and refuse to permit any early withdrawal of funds. When a new bank takes over the CD, it’s not required to honor the interest rate paid by the failed bank, so that owners have to accept lower interest rates or take their money out and shop around.

Fixed annuities are insured by a fund established by all insurance companies operating in the state the annuities were issued in. If the insurance company fails, all the other companies assume the failed company’s policies. The degree of safety is just as strong as that offered by the FDIC.

Profitability

CD’s are issued for a fixed period of time at a fixed interest rate, paid when the CD matures. Many people allow their banks to “roll over” the CD plus interest into a new CD at a new interest rate. The interest paid is reported to the IRS, whether or not included in the rollover. The interest on the CD, then, is effectively reduced by the amount of tax due. For instance, a person paying an effective tax rate of 20% with a $25,000 CD paying 2% interest ($500), receives an effective interest rate of 1.6%, because the interest paid incurs a tax liability of $100.

Fixed annuities, by contrast, don’t incur a tax liability until the interest is actually paid over to the annuitant. Thus, if the annuity pays the same rate as a CD, in reality, it’ll be paying a greater return.

Another feature unique to annuities is that they can be “annuitized” - converted into a guaranteed income stream for life. A CD offers no such benefit. The annuitant can arrange annuity payments for a “period certain” so that if he dies before that time, the payments will continue to his beneficiary. An annuity annuitized for a period certain of five years – 60 monthly payments – would pay out more than the amount of the original annuity. If the annuitant is still alive after 5 years, the monthly payments will continue.

Accessibility

CD's cashed in early – by even a day – incur a substantial penalty, usually three months’ interest. Many banks won’t permit partial withdrawals, requiring instead that the entire CD be liquidated, forcing the owner to pay a higher penalty. And while banks usually honor an owner’s request to cash in a CD early, they’re not required to do so. In some cases, when the bank fails and the obligation of the CD is taken over by another bank, the new bank will refuse to honor early withdrawal requests.

If the owner of a CD dies, the CD becomes part of his estate, becomes public knowledge, and is distributed in accordance with his will (or if intestate, by a judge).

Fixed annuities also have penalties for withdrawing funds early, however, most fixed annuities permit owners to withdraw up to ten percent without penalty anytime after the first year. Many insurance companies permit additional withdrawals if certain qualifications are met – for example, if the owner is in a long-term care facility. The amount of the penalty declines over time as well.

Annuities are private contracts between the insurance company and the owner. When the owner dies, the annuity is paid over privately to the beneficiary, and in most cases is neither included in the estate nor subject to probate.

Because banks automatically roll over CD’s with accrued interest, there’s only a very short window of time every year during which an owner can withdraw all his money without penalty. Annuities’ surrender charge declines over time and expires, but there’s no requirement that the owner purchase a new annuity or cash in the current one. Thus, after the surrender period expires, there’s no penalty at all on withdrawing funds from a fixed annuity. Fixed annuities, then, are far more convenient than CD’s in terms of being able to access funds.

Conclusion - Fixed Annuities vs CD's

In essence, CD’s and fixed annuities are equally safe, but bank failure may adversely affect a CD owner where failure of the insurance company won’t harm an annuity owner. Annuities are inherently more profitable than CD’s, more convenient in terms of being able to access funds, and clearly superior if the owner dies. Thus, when comparing fixed annuities vs. CD’s, fixed annuities are clearly the better choice.