Low-risk retirement savings options include fixed annuities and certificates of deposit (CDs). To determine which of these products is best for you, you should take into account a few significant differences.
An insurance company-backed contract known as a fixed annuity offers a guaranteed return after a predetermined amount of time. The term “fixed” refers to fixed interest rates, which indicate that you are certain of the growth and income potential of your annuity. The goal is to give an income stream that is secure, steady, and predictable—a quality that most retirees find important.
Choosing the right investment for your retirement can be a daunting task. Two popular options are annuities and certificates of deposit (CDs). Both offer guaranteed returns, but they have different features and benefits. This article will help you understand the key differences between annuities and CDs and determine which is the better option for your retirement savings.
Understanding Annuities
An annuity is a contract between you and an insurance company. You make a lump-sum payment or a series of payments, and the insurance company guarantees to pay you a certain amount of income in return, either for a set period or for the rest of your life.
There are two main types of annuities:
- Fixed annuities: These offer a guaranteed rate of return for a set period. The rate of return is typically higher than what you would earn on a CD, but it is not as high as the potential return you could earn on stocks or other investments.
- Variable annuities: These are similar to fixed annuities, but the rate of return is tied to the performance of a specific investment portfolio. This means that you have the potential to earn a higher return than with a fixed annuity, but you also have the risk of losing money.
Understanding CDs
A CD is a type of savings account that offers a guaranteed rate of return for a set period. You cannot withdraw your money before the term ends without facing a penalty. CDs are typically offered by banks and credit unions.
There are two main types of CDs:
- Traditional CDs: These offer a fixed rate of return for a set period. The rate of return is typically lower than what you would earn on an annuity, but it is guaranteed.
- No-penalty CDs: These allow you to withdraw your money before the term ends without facing a penalty. However, the rate of return is typically lower than what you would earn on a traditional CD.
Annuities vs. CDs: Key Differences
Here is a table summarizing the key differences between annuities and CDs:
| Feature | Annuities | CDs |
|---|---|---|
| Type of investment | Contract with an insurance company | Savings account offered by banks and credit unions |
| Rate of return | Guaranteed, but can vary depending on the type of annuity | Guaranteed, but typically lower than annuities |
| Risk | Low risk, but there is a risk of losing money with variable annuities | Very low risk |
| Liquidity | Limited liquidity, especially with fixed annuities | Limited liquidity, but some CDs allow early withdrawal without penalty |
| Taxation | Tax-deferred growth, but taxed upon withdrawal | Interest earned is taxed annually |
Which is Better for Retirement?
The best choice for your retirement depends on your individual needs and circumstances. Here are some factors to consider:
- Your risk tolerance: If you are risk-averse, then a fixed annuity may be a better option for you. If you are comfortable with more risk, then a variable annuity or a CD may be a better choice.
- Your time horizon: If you are planning to retire soon, then a CD may be a better option for you. If you have a longer time horizon, then an annuity may be a better choice.
- Your financial goals: If you need a guaranteed income stream in retirement, then an annuity may be a better option for you. If you are looking for the potential to earn a higher return, then a CD or a variable annuity may be a better choice.
Both annuities and CDs can be valuable tools for retirement planning. The best choice for you depends on your individual needs and circumstances. Carefully consider your risk tolerance, time horizon, and financial goals before making a decision.
Additional Resources
- New York Life: https://www.newyorklife.com/articles/cd-vs-fixed-deferred-annuity
- Bankrate: https://www.bankrate.com/banking/cds/fixed-annuities-vs-cds/
FAQs
Q: What is the difference between a fixed annuity and a variable annuity?
A: A fixed annuity offers a guaranteed rate of return for a set period. A variable annuity is similar to a fixed annuity, but the rate of return is tied to the performance of a specific investment portfolio.
Q: What is the risk of investing in an annuity?
A: The risk of investing in an annuity depends on the type of annuity. Fixed annuities have a low risk, but there is a risk of losing money with variable annuities.
Q: How are annuities taxed?
A: Annuities are taxed on a deferred basis. This means that you do not pay taxes on the interest earned until you withdraw the money.
Q: What is the difference between a CD and a no-penalty CD?
A: A traditional CD does not allow you to withdraw your money before the term ends without facing a penalty. A no-penalty CD allows you to withdraw your money before the term ends without facing a penalty, but the rate of return is typically lower.
Q: Which is better for retirement, a CD or an annuity?
A: The best choice for your retirement depends on your individual needs and circumstances. Consider your risk tolerance, time horizon, and financial goals before making a decision.
Who should consider CDs?
Because there are so many options for term lengths and investment amounts, certificates of deposit (CDs) are a popular savings option for people of all ages and income brackets.
They are offered by almost all financial institutions, in part because they can be used to achieve a variety of savings objectives. Use CDs to save for a down payment on a home or for longer-term objectives like financing a weekend getaway.
However, CDs are generally the greatest option for “those interested in short-term returns with low risk,” according to Shahkarami
Who should consider fixed annuities?
According to Sean Shahkarami, CEO of Texas-based data management company Opilio and certified public accountant, fixed annuities are best suited for “older people who are not quite ready for retirement” and “want to grow and protect their retirement income” because they are designed with retirement planning in mind.
You ought to think about how long you wish to commit your funds.
According to Secco, “those investing for three or more years may find fixed annuities more suitable.” “During the accrual period, the interest on fixed annuities is deferred without being distributed immediately.” ”.