Fixed Annuities vs. CDs: What’s Best for Your Retirement

Key Takeaways 

• An annuity is a contract between an individual and a life insurance company that provides steady, guaranteed income throughout the person’s life.

• A CD is a type of savings account that pays, for an agreed-upon period, a fixed interest rate on money held.

• CDs provide safety and fixed interest rates that can often exceed those offered by many bank accounts.

Two popular yet distinct retirement income strategies for pre-retirees and recent retirees are fixed annuities and certificates of deposit (CDs). Understanding each of them is essential for retirement planning. But which one is preferable over the other? How are informed decisions made concerning them?

What is an Annuity?

An annuity is basically a contract between an individual and a life insurance company that provides steady, guaranteed income throughout the person’s life. 

In other words, it is an agreement in which a person makes a series of payments called premiums or a lump-sum payment. In exchange, the annuity buyer gets consistent payments that start right away or at some future point.

Annuities are often employed as part of a retirement plan and are particularly popular among those who lack an employer pension. In the second quarter of 2022, annuity sales in the U.S. increased a record 22% to $77.5 billion, according to trade association LIMRA.

How they work is, after an annuity type is chosen, participants pay into a plan bought through an insurance company, broker, or bank. The insurance company invests the payment, and the account earns interest. Annuity payments, when the buyer decides to receive them, will be a return of the initial investment plus interest, less fees. 

A tax-deferred annuity means money is not taxed while it is in the account. Such delayed taxation helps account values grow.

Note that annuity structures, terms, fees, payouts, penalties, and flexibility vary broadly. There are a number of annuity types, with a fixed annuity offering guaranteed payments and duration. This makes a fixed annuity one of the most predictable financial investments available, and one in which the insurance company bears the investment risk.

Other types of annuities are:

• Immediate. Payouts start right away.
• Deferred. Payouts begin at an established future date.
• Indexed. In addition to guaranteed returns, there is an option to share in investment market earnings.
• Variable. Rather than guaranteed, accumulation and payout are variable. However, agreements may contain minimum guarantees at an extra cost. There are also charges and fees to consider.

What is a Certificate of Deposit?

A CD is a type of savings account that pays, for an agreed-upon period, a fixed interest rate on money held.

It differs from regular savings accounts in that a penalty is incurred unless the funds remain untouched for the term’s entirety. To offset the lack of withdrawal flexibility, a CD typically pays a higher rate than a savings account.

While there are variable-rate CDs available that, if rates rise, could earn a higher return, most CDs are fixed. That means the holder will know precisely how much will be earned by the term’s end.

There are various term lengths available, during which the holder agrees to leave funds deposited to skirt any penalty. For example, there are six-month, one-year, and 18-month CDs. When the CD matures, funds may be withdrawn with no penalty.

The particular financial institution where the CD is opened will determine contract aspects. Those include, for example, early withdrawal penalties and whether the certificate of deposit will be reinvested automatically.

Following CD establishment and funding, the bank or credit union will administer the account just as it would other deposit accounts. In addition to monthly or quarterly statements, periodic interest payments are deposited to the CD balance, where the interest will compound.

In general, CDs provide fixed and safe interest rates that can often exceed rates offered by many bank accounts. They are especially popular among those who seek to eschew market risk and volatility but want to earn more than most savings, checking, or money market accounts.

Annuities and CDs Compared

The difference between annuity and CD is important to understand, although both are widely used savings vehicles and share other similarities.

• Both vehicles are considered low-risk investments.
• A CD may be better for shorter-term financial goals.
• Annuities are more commonly used for retirement.
• CDs provide, for a specified period, a guaranteed return rate. With fixed deferred annuities, an interest rate is locked in for an initial period, then may be adjusted annually.
• Earnings accumulate tax deferred in fixed deferred annuities. Because interest on a CD is taxable, it will add to the holder’s income for the year. When paid out, earnings within a fixed annuity are subject to income taxes.
• An annuity account’s value goes to beneficiaries, while a CD may be subject to probate.
• Early CD withdrawals are subject to interest penalties. Withdrawals during the surrender charge period of deferred annuities are subject to surrender charges.

Annuity vs. CD: Which Is Right for You?

When deciding between an annuity and a CD, the amount of time needed to save should be a primary factor. For example, a certificate of deposit may be the better choice for near-term goals such as a new vehicle or down payment for a house. Annuities are most designed to help people accumulate retirement funds.

Tax deferral, offered by fixed deferred annuities, may be favored by someone who is saving for retirement. Interest on a CD is counted as taxable.

If there is concern about taking care of loved ones, note that the annuity account’s value will go directly to beneficiaries. A CD, though, may need to go through rebate.

If CD funds are needed before the account’s maturity, an interest penalty will be incurred. With a fixed deferred annuity, money may also be accessed. However, there generally will be surrender charges if withdrawals are taken during the surrender charge period.

In terms of distribution, a CD’s value can be taken in a lump sum or renewed. With a fixed deferred annuity, the holder may choose to receive a lump sum or a lifetime income option. This could be a consideration for retirement.

Cons of Getting an Annuity

When it comes to fixed annuity vs CD pros and cons, annuities offer regular payments, lifetime income, and tax-deferred growth. They also offer guaranteed return rates and survivor benefits.

However, annuities also tend to have high fees and commissions, and have complex contractual language. Further, surrender charges will decrease the investment’s value and return.

While earnings accumulate tax deferred with fixed deferred annuities, they are treated as taxable income when withdrawn.

Cons of Using a CD

CDs do generally provide safety, better returns than savings accounts, and fixed, predictable returns. They also offer a broad selection of account terms and options.

However, they are relatively inflexible during the term and have limited liquidity. There is also an inflation risk regarding rates, as well as a reinvestment risk as the APY could be lower. Further, with CDs, taxes will be owed on the accrued interest.

Annuity vs CD: Which Should You Choose?

Those looking for a safe place for their money should consider the benefits and drawbacks of annuities and CDs.

In deciding between the two, individuals should consider their financial situation, how soon they will need their money, and their financial plans and goals. 

It may be advisable to seek the help of a financial planner, who can help with the decision.

Note that Yieldstreet — one of the leading alternative investment platforms — allows investors to use private-market alternatives for portfolio diversification. 

This is particularly important to know for retirement planning, as Yieldstreet’s tax-advantaged IRA comprises assets that cover an expansive range of classes, including art and real estate.

Yieldstreet’s program supports traditional IRAs in addition to Roth, SIMPLE, or SEP individual retirement accounts. It also backs 401(k) accounts.

Overall, the goal is to render retirement portfolios less dependent upon a stock market that is constantly fluctuating, while maximizing the potential for better long-term returns.

Alternative Investments and Portfolio Diversification

Alternatives can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other alternative investments.

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary 

Understanding the differences, advantages, and drawbacks of annuities and CDs will empower retirees and pre-retirees. With this guide, they can make informed decisions that align with their financial goals, risk tolerance, and long-term retirement needs.