Our clients often ask us to explain the difference between an annuity and a Certificate of Deposit (CD). First, let’s define both CDs and annuities.
Definition of CD:
“A Certificate of Deposit is a written acknowledgment from a bank that it has received from the person named a specified sum of money as a deposit, often for a fixed term at a specified interest rate.”
Definition of Annuity:
“An annuity is a specified income payable at stated intervals for a fixed or a contingent period, often for the recipient’s life, in consideration of a stipulated premium paid either in prior installment payments or in a single payment.”
So what’s the difference between an annuity and a CD?
Based on the definitions, some of the similarities between CDs and annuities become apparent: in return for a specified guaranteed income (interest rate), you deposit a sum of your money for a defined period of time. The most obvious difference you’ll notice from the definitions is that a CD is issued by a bank, whereas an annuity is guaranteed by an insurance company. While money with a bank is protected by the FDIC, it’s important to research the financial strength of the insurance company issuing an annuity. One way to help determine the issuing company’s financial strength is through independent rating companies, such as Standard & Poor’s and AM Best. We include company ratings on our annuities rates page.
Do annuities and CDs have tax advantages?
Beyond the basic differences, our clients are usually interested in the different tax implications for CDs and annuities. The interest earned on a CD is taxed each year. The money earned from an annuity, on the other hand, is tax-deferred. In his blog for The Huffington Post, Jason Alderman does a great job of explaining the tax implications of an annuity:
“One reason many people purchase annuities is because their account grows tax deferred — that is, when you eventually do receive payments, your contributions themselves are not taxed, but any earnings they generate are taxed at your regular income tax rate. Unlike other tax-deferred retirement accounts, such as 401(k) plans and regular IRAs, annuities have no annual contribution limit. However, as with those other accounts, you’ll pay a 10 percent federal tax penalty on money withdrawn from an annuity before age 59 ½.”
It’s important to note the IRS rule regarding withdrawal from an annuity prior to age 59 ½. This rule can impact the age at which we recommend purchasing an annuity rather than a CD. Because of the restrictions on annuity funds prior to age 59½, a younger person might choose a CD over an annuity for saving purposes. Meanwhile, a person closer to 59 ½ or older than 59 ½ might choose annuities because interest rates are sometimes significantly higher.
Annuities can create retirement income
Where annuities really shine is with retirement income. Some annuities, such as a Multi-Year Guaranteed Annuity (MYGA), create guaranteed income for a set duration. Other annuities have a feature that allows an owner to receive a lifetime income stream. In an annuity with a lifetime income feature the insurance company agrees to pay a specified monthly income to the owner and guarantees the income will continue for the owner’s entire life – even if the person lives a long time past typical life expectancy. Annuities like this can even be designed to pay a joint income stream (income for life for a married couple).
Advantages of CDs:
- FDIC Insured
- Access to funds prior to age 59 ½
Advantages of Annuities:
- Tax deferred growth
- Potential for guaranteed lifetime income
- Sometimes higher interest rates
While these are some of the basic differences between CDs and annuities, the question of which device is best ultimately depends on various factors specific to each person’s particular circumstances and goals. We can walk you through each of these factors, including the various pros and cons of annuities, and help you decide whether your individual situation is better served by a CD or annuity. Whichever direction you choose, it’s always a great decision to put money away for the future.
Request a Free, No-Obligation Annuity Rate Quote
We’re also happy to provide you with a free, no-obligation custom annuity rate quote.
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Disclosure: An annuity is an insurance product that can be used as part of a retirement strategy. Annuities are not FDIC insured, not bank guaranteed, and may lose value if surrendered early. An annuity is subject to the claims-paying ability of the issuing insurance company. Before buying an annuity, consider the objectives, risks, charges, and expenses of the annuity. Please read all disclosures carefully before buying an annuity. Please review your issued annuity policy during any “free look” term offered by the insurance carrier to ensure accuracy. Because annuity interest rates fluctuate, any rates listed on this page might not be current. As such, any annuity rates listed on this page are only believed to be accurate as of the date shown at the top of the page. Montana Life Group is compensated by insurance carriers for the sale of annuities. Montana Life Group has prepared the material on this page for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
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