Annuity or Certificate of Deposit (CD) for Retirement
Apr 17, 2025, 5:40:43 PM | Reading Time: 6 minutesRetirement planning: annuities or certificates of deposit When it comes to saving for retirement, there are numerous strategies available, each offering their own advantages depending on your financial goals and risk tolerance. Two common options are annuities and certificates of deposit (CDs), which can help supplement a retirement income plan and offer financial security for the future. Here’s a closer look at the advantages of annuities and CDs, the key differences between the two, and how to determine which one may be a good match for personal retirement goals.
Key differences between an annuity and a CD
An annuity and a certificate of deposit (CD) are both financial products designed to offer stable, predictable returns. A fixed annuity can provide a guaranteed income stream for a set period or for life, depending on the contract, while a CD offers a fixed interest rate over a specified term with the principal returned at maturity along with any interest earned.
Both options are relatively safe, often backed by insurance companies or financial institutions, and can provide guaranteed interest. However, there are some key differences between an annuity and a CD that can impact how they fit into a retirement plan.
|
Differences |
Certificate of Deposit (CD) |
Annuity |
|---|---|---|
| Payout structure | Pay interest over a set term and return the principal at the end.1 | Typically provide periodic payments which can be structured to last for a specific number of years or for the rest of an individual’s life. |
| Duration | Have a fixed term, generally ranging from a few months to several years. 1 | Can be long-term contracts, often providing income for life. |
| Liquidity | Funds are usually locked in for the term length, and early withdrawal may result in penalties. 1 | Can have surrender periods and penalties for early withdrawals, but the structure often varies depending on the type of annuity. |
| Tax treatment | Typically subject to tax on the interest earned in the year it is paid. 1 | May offer tax-deferred growth, meaning that earnings are not taxed until they are withdrawn. |
| Flexibility | Have a fixed term and interest rate. 1 | Can offer flexibility with additional riders that can adjust the income or payout terms based on the annuitant’s needs. |
| Where to purchase | Typically offered by banks or credit unions. 1 | Generally purchased through insurance companies often with the help of a financial professional who can assist in selecting the right type of annuity based on specific retirement goals. |
When it comes to creating a retirement savings strategy, understanding the differences between an annuity and a CD can help determine which may be more suitable for meeting long-term financial goals.
Pros and Cons of CDs and Annuities
To further evaluate these options, consider the following pros and cons:
Certificates of Deposit (CDs)
Pros:
- Predictable returns: CDs offer a fixed interest rate for a specific term, providing predictable returns.
- Low risk: CDs are generally considered low-risk investments, especially those offered by FDIC-insured banks.
- Principal protection: The principal invested in a CD is typically returned at maturity.
Cons:
- Limited growth potential: CD interest rates may be lower than other investment options, limiting growth potential.
- Liquidity constraints: Early withdrawals can result in penalties, reducing liquidity.
- Taxed annually: Interest earned is taxed annually.
Annuities
Pros:
- Guaranteed income: Annuities can provide a guaranteed income stream, offering financial security in retirement.
- Tax-deferred growth: Earnings grow tax-deferred, potentially allowing for greater long-term growth.
- Flexibility: Some annuities offer riders that can adjust income or payout terms.
Cons:
- Fees and expenses: Annuities may have higher fees and expenses compared to CDs. These are charged even in years that there is not an interest credit.
- Liquidity constraints: Early withdrawals can result in surrender charges or penalties.
- Complexity: Annuities can be complex financial products, requiring careful consideration. o Not FDIC insured
How are CDs and Annuities taxed?
CDs are taxed on the interest earned each year, regardless of whether the owner accesses the funds or if the CD has reached maturity. This interest is considered taxable income, unlike annuities, which grow tax deferred.
Advantages of using CDs for retirement
CDs can offer predictable returns and are federally insured. They typically do not experience the same volatility as the stock market. Securing a CD's fixed rate during periods of high interest rates could provide consistent returns over several years. Furthermore, CDs may be a suitable option for preserving additional cash reserves beyond emergency savings, potentially offering higher yields compared to other bank accounts.
Advantages of annuities for retirement
In exchange for premium payments, a fixed annuity can grow tax deferred and provides a stream of guaranteed income payments in retirement. Once you retire, funds can typically be withdrawn as a lump sum or paid out periodically as guaranteed monthly payments. Some annuities offer lifetime income and provide payments for the remainder of the annuitant’s life.
With a fixed index annuity (FIA), premiums are allocated to interest-crediting strategies, such as a fixed option with guaranteed interest or index strategies linked to market performance. This provides the potential for growth based on a market index, while also offering protection from market downturns. So even if the market goes down, earnings are locked in and protected from loss.
What is a one of the primary uses of an annuity?
One of the main uses for an annuity is to provide guaranteed income in retirement. Designed specifically for this purpose, annuities provide predictable payouts. Unlike savings tools like CDs, which are typically better suited for short-term goals or specific purchases, annuities can help provide financial stability throughout retirement. By adding an annuity to a diversified financial plan, it’s possible to create both growth potential and a reliable income stream, offering peace of mind and protection against outliving your savings.
Build a customized retirement income strategy
Creating a retirement income plan is essential for ensuring financial stability in your later years. By taking the time to explore and understand the various options available, you can identify the solutions that best align with your unique needs and long-term goals. Working with a financial professional can also help assess your circumstances and design a strategy that balances growth potential, risk, and guaranteed income, and creates a roadmap that helps turn retirement dreams into reality.
The term financial professional is not intended to imply engagement in an advisory business in which compensation is not related to sales. Financial professionals that are insurance licensed will be paid a commission on the sale of an insurance product.
1 Investopedia, What is a Certificate of Deposit (CD? Pros and Cons) Nov. 22, 2024
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