Annuities – particularly fixed interest annuities – are similar to certificates of deposits, or CDs, in a variety of ways. However, there are differences between these two investment products, too. Deciding on whether to purchase an annuity or a CD can be a big decision as both products typically put a lock on your money for a specified period of time.
Fixed interest annuities are just one type of annuity. Generally, an annuity can have either fixed or variable interest. With a fixed interest annuity, the annuitant is guaranteed a specified interest rate for a specified period of time. On the other hand, a variable interest annuity has interest rates that change often based on market trends, since the interest rate of a variable interest annuity is usually mapped to mutual funds or other stock market-reliant investments. Annuities are also either deferred or immediate, depending on when the annuitant chooses to receive payments. Here at High Interest Annuities, our clients are able to choose between both deferred and immediate annuity plans, both of which provide a fixed interest rate.
Positives of Annuities
Annuities are financial products offered by insurance companies, whereas certificates of deposit (CDs) are financial products offered by banks. An annuity is like a life insurance policy in some ways, which is why it is offered by insurance companies, but it can actually be better defined as the opposite of a life insurance policy. While the purpose of a life insurance policy is to protect a family or beneficiaries in the event of a death, an annuity is intended to protect the annuitant throughout his or her life by offering regular, guaranteed payments at a frequency in which the annuitant chooses. Banks offer a variety of products to their customers and have to take all of their products into consideration when trying to make a profit, but insurance companies focus solely on insurance. Therefore, insurance companies have a limited number of products to price out and can better predict their profitability, resulting in potentially higher interest rates available on their annuity products.
On the topic of interest rates, CDs tend to follow the federal funds rates set by the government. As of March 2020, after an emergency meeting of the Federal Reserve, the fed funds rate is actually now 0.00% – 0.25%, the lowest that it has ever been. This is a good sign for people who are looking to borrow money for a vehicle or a home mortgage, but it is not that great for those who are looking to invest. Because of this, many banks have chosen to lower their CD rates and, as of this writing, one of the best rates that you can get on a 5-year CD is 1.90%. By comparison, our six-year fixed rate annuity, which guarantees the same interest rate for six straight years, is at 3.35%, and even our two-year fixed rate annuity is at 2.35%!
Annuities also have tax benefits that are not seen with CDs. Interest gained in an annuity is tax-deferred; that is, an annuitant does not pay any tax on the interest earned in their annuity until they begin receiving payments.
Negatives of Annuities
While we would love to be able to say that annuities have no negatives, this is unrealistic. There are several negatives faced with annuities. If you purchase an annuity and the period of guaranteed interest passes but you are not yet of retirement age, you cannot take the money out of the annuity without penalty. Indeed, withdrawing from an annuity before age 59 1/2 results in a 10% withdrawal penalty, since annuities are meant to be funds for retirement and have tax benefits as such.
Another negative, or con, of annuities is that when the economy is booming and the stock market is on the rise, it is very likely that annuity rates will be much less than the average return for a positive mutual fund. However, investing in the stock market has great risks, and if the market goes into the decline, you can lose the money that you have invested, too. An annuity may not give you the best returns, but you will know that if you purchase a fixed interest annuity, your money is guaranteed to grow, even if at a low rate of interest.
Positives of CDs
A certificate of deposit, or CD, can be purchased at any adult age and provides a minimal risk investment regardless of age. This means that even if you are in your 20s or 30s, you can reap the benefits of investing in a CD without needing to wait until retirement.
CDs are also offered by banks, meaning that the money invested in a CD is backed by the Federal Deposit Insurance Corporation, or FDIC, providing assurance that your funds are safe in the event that the bank dissolves.
Like fixed interest annuities, CDs offer fixed, predictable returns that are much better than rates offered by banks for savings accounts. This makes them a safe choice, with limited fees involved.
Negatives of CDs
One of the biggest negatives, or cons, of CDs is that the CD owner is taxed each year on the interest gained during that year. Even before the person is able to receive and use the interest, he or she is required to pay tax on it. If the CD is for a large amount of money, and has a decent interest rate, the tax that must be paid each year on the interest earned could be significant.
Another disadvantage is that the rate of interest earned in a CD does not always exceed the rate of inflation. If you are in the middle of the interest accumulating years of a CD, and the economy changes where the rate of inflation skyrockets, you may find that the interest rate that you are earning on your CD is actually less than the inflation rate. This is not something that you can easily predict, but given the limited access to the funds in a CD, this is a potential risk that one takes.
The interest rates that banks offer for CDs typically follow along with the overall market and economy interest rates. Where insurance companies may be able to afford to offer above-average interest rates, banks do not always have the profit margin available to do so. Furthermore, banks must be responsible to their creditors whereas annuities are sold by insurers who may be private companies or even non-profits, focused more on the benefits to their clients and less on their stock price or market value.
Summary
After reading this post, you may be wondering: what do I do? Ultimately, each individual’s situation and financial position is different and there is no one-size-fits-all solution. However, with the economy and stock market declining, now is a great time to consider the options that you have available for retirement in the form of a high interest, fixed annuity.
Interested in learning more about how a fixed annuity can improve your retirement plans? Contact us today for a free, no obligation review and discussion!