Annuity vs. CD: Which is best for retirement and savings goals?
Retirement planning often involves a range of tools to help Americans achieve their goals. For investors seeking stability in their portfolio, annuities and certificates of deposit (CDs) are two popular options. CDs are bank deposits with a guaranteed rate that are time-locked. Annuities are contracts with insurers that can potentially offer guaranteed growth or income.
Neither of these instruments typically has direct exposure to the stock market, though some annuities may include limited market exposure. Both CDs and annuities provide predictability, but it’s important to select the right investment for your needs. Debating annuities vs. CDs requires understanding how each operates, tax implications, and what you can expect to earn. This guide compares the two to help savers and retirees decide which tool is best for them.
Understanding annuities: Types, features, and risks
An annuity is a contract between an individual and an insurance company. The purchaser can deposit funds to grow tax-deferred for later or convert them into income payments, depending on whether they choose a deferred or immediate annuity.
There are four basic annuity types. They include:
- Fixed: Best for investors wanting stability with limited risk.
- Variable: Ideal for growth-minded investors wanting some stock market exposure, albeit with higher fees.
- Fixed indexed: Best for a balanced approach between principal protection and market exposure.
- Immediate: Ideal for people wanting income within one year of purchase, with reduced risk.
Fixed annuities provide predictability, as they earn a guaranteed rate for up to 10 years. At the income phase, investors receive a fixed amount during the payout period. Such income can be beneficial for retirees seeking cash flow.
Variable annuities differ in that they have subaccounts tied to the market, which adds complexity and fees. Fixed indexed annuities blend features of both fixed and variable annuities by offering some market participation with downside protection against losses. Immediate annuities, meanwhile, are designed to begin paying income shortly after purchase, making them more common among retirees seeking a predictable cash flow.
Predictability aside, people also buy annuities for tax-deferral opportunities. Nonqualified money means you pay taxes when you withdraw, not each year. Unfortunately, costly surrender charges make liquidity a problem for many investors. Fees and insurer solvency are also important considerations.
Despite the complexity, annuities can be a good fit for some investors. “People say a lot of things about annuities because they can be complex to understand, but they provide guarantees that other investments cannot. The biggest knocks on annuities and CDs are that they may not grow as much as funds invested in the market, and they can be difficult to liquidate. While both can be true, there are tools within these options that outweigh those downsides,” says Jason LaBarge, president and financial advisor at LaBarge Financial.
What are CDs? Terms, interest rates, and safety
CDs are bank products that let savers deposit money for a set term with a guaranteed rate. The deposit instrument offers some flexibility, as term lengths range from several months to five years or longer.
CDs can be a good option for people who want to park cash with no exposure to the stock market or save for a near-term goal. “CDs operate similarly to annuities and offer stability and growth. The difference is that CDs can be used for shorter-term savings goals, such as saving to buy a house or another large purchase,” notes LaBarge.
A key area to consider when comparing CDs vs. annuities is safety. CDs are covered by Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA) insurance, depending on whether you have the account at a bank or a credit union.
Regardless, FDIC or NCUA insurance covers CDs up to $250,000 per depositor, per insured bank, per ownership category. Annuities offer safety via state guaranty associations, but coverage varies by state.
People traditionally must wait until the end of the CD term to access funds. If you withdraw funds early, you incur an early withdrawal penalty, which is usually several months’ worth of interest. A CD ladder can be an alternative for people who want to deposit sizable funds while still having predictable access to cash.
Despite limited liquidity, CDs are relatively transparent, as you can easily compare terms and rates across local and online banks.
Comparing interest rates: Annuities vs. CDs
It is important to consider interest rates when comparing a fixed annuity vs. a CD. Annuities generally offer higher interest rates, as they have longer holding periods. Insurer portfolios and risk pooling also influence rates.
CDs often pay lower rates. The shorter the term, the lower the rate you receive in many cases. CDs are priced by competition and bank funding needs. Comparing annuities vs. CDs requires knowing why rates differ and how rising interest rates can impact each.
With rising rates, CDs pose opportunity risks. For example, if rates go up soon after purchase, you may feel stuck earning a lower rate, which is why CD ladders can be advantageous.
Annuities aren’t immune to rising interest rates. Fixed and income annuities will pay higher lifetime payments for new buyers. If you already own either, there’s limited benefit until the term ends, or the contract allows resets.
Knowing how long you want to tie up your cash is valuable. “CDs are great for stashing excess cash holdings that are needed for everyday bills. We typically recommend a laddered approach to allow clients flexibility regarding how long they are required to keep the funds in a specific CD, such as six months, one year, and three-year periods,” says John Foard, CFP®, co-founder of Crown Advisors, LLC.
Annuities generally cover longer-term needs. “Typically, we use an annuity to ‘fix’ a specific amount of a client’s income in retirement. This is usually a complement to their Social Security income and/or pension to help satisfy as many of their ‘fixed’ expenses as possible, leaving their other investments in market-based accounts as a supplement to their spending desires,” adds Foard. Speaking with a financial advisor can be worthwhile if you’re unsure which one to choose.
How withdrawal rules differ for annuities and CDs
In any CD vs. annuity comparison, it is vital to know the withdrawal rules for each. CDs are straightforward. You can’t withdraw funds until the term ends; otherwise, you risk losing interest depending on the length of the CD.
When the CD matures, you have a grace period of up to two weeks to withdraw the funds without issue. If liquidity is a concern, housing excess cash in a high-yield savings account is a good solution.
| Feature | CDs | Annuities |
|---|---|---|
| Early access | Usually allowed | Usually allowed, but often limited |
| Main penalty | Months of interest | Surrender charge (%), declining over time |
| Extra tax penalty? | No special age rule | Possible 10% before 59 1/2 (taxable portion) |
| "Free" withdrawals | Sometimes via no-penalty CDs (lower APY) | Often limited % per year (contract-specific) |
Annuities are typically not better for liquidity than CDs. Withdrawals from CDs incur fees, whereas annuities incur surrender charges. Such charges can range from 7% to 10% for up to a decade, with the higher charges occurring early in the contract. That’s not to mention potential tax hits for those under 59½.
Annuities may offer a free withdrawal allowance of 10% of the contract value annually, but exceeding it can be expensive. Withdrawal options for annuities vary from scheduled income payments to full surrender, with possible associated fees.
“Regardless of which product you choose, it is imperative to understand how the penalties work, and if tying up your funds for a longer period of time in an annuity would potentially put you in a bind financially, an annuity would be a bad choice,” notes Foard.
Matching annuities and CDs to investor profiles and goals
Both CDs and annuities can be practical tools for a retirement portfolio. However, they may not both fit all investors. Questions to ask yourself when considering a CD or annuity include:
- What is my timeline?
- When do I need access to this money?
- What is my risk tolerance?
- How will this impact my taxes?
LaBarge argues that it depends on your needs. “It depends on the saver’s objectives. If they are looking for a long-term investment, similar to funding a retirement account, annuities are likely the better option when comparing the two, especially if 401(k) and IRA contributions are maxed out. CDs may be more appealing to younger savers who are looking for conservative and stable growth and who can’t afford the risk of losing their capital,” adds LaBarge.
Knowing that, CDs are best for conservative savers who value NCUA and FDIC protection and want simplicity. Together, those features offer flexibility and capital preservation. If you’re years from retirement, saving for a near-term major expense, and you value flexibility, a CD or a CD ladder may be the best option.
Annuities may be a better fit for people at or near retirement who want to guarantee income to cover essential expenses. If you have maxed out other retirement accounts and can leave money untouched, an annuity may fit.
Tax implications and safety: What to know
Taxes and protection are key components not to overlook when comparing CDs vs. annuities. Where you hold the CD dictates taxation of interest. Interest is taxed as ordinary income in the year it’s credited, but if you hold it in a retirement account, it is tax-deferred. “Keep this in mind if you are trying to keep your annual tax bill to a minimum, especially if you are considering using a significant amount of funds to buy a CD or series of CDs,” says Foard.
Foard explains that annuities are treated differently for tax purposes. “The taxes are deferred until you remove the income from the annuity. If the annuity is nonqualified (meaning not an IRA or Roth IRA, for example), when you start withdrawing funds from the vehicle, the taxation method is LIFO (last in, first out), and withdrawals will be taxed at ordinary income rates,” adds Foard. There are numerous complexities when contemplating an annuity, so speak with an advisor to create an informed plan.
CDs are protected up to $250,000 per depositor, per insured bank, per ownership category. Annuities don’t enjoy the same protection, but state guaranty associations insure them.
Protection depends on your state’s guaranty limits and what type of annuity you own. Caps vary but are usually around $250,000 in present value per owner and insurer. Consult the National Organization of Life & Health Insurance Guaranty Associations to learn more and consider diversifying across insurers if you’re investing a large amount in annuities.
Choosing between an annuity and a CD
While they help investors accomplish similar goals, the differences between annuities and CDs are often stark. CDs often offer more liquidity, albeit at a lower interest rate and with a straightforward tax situation. If you’re saving for a significant near-term expense, compare the best CD rates to identify a suitable option. For people wanting stability in retirement and possible long-term income guarantees, annuities may be a better fit. Speaking with a trusted financial advisor is a wise next step toward identifying your goals and the best tool to achieve them.
