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CDs or Fixed Annuities: Which is a better way to save for retirement?

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If you want to avoid running out of money during retirement, it’s crucial to plan ahead and save enough to support yourself during your 70s, 80s, and even 90s. Additionally, it’s essential to choose a suitable place to store your retirement income. This can sometimes be more challenging than saving the money in the first place.

When planning for retirement, you may need to decide whether to opt for certificates of deposit (CDs) or fixed annuities. Even though both are low-risk options suitable for cautious investors, there are significant differences between them that you should take into account.

What is a CD?

A CD is a type of bank account that can be obtained from banks or credit unions. It provides a guaranteed rate of return for a specific length of time which you choose when you open the account. The term length can range from a few months to a few years.

When you opt for a fixed rate with a CD, you must keep the funds locked in for the entire term. If you withdraw the money early, there will be an early withdrawal penalty. This penalty could cancel out the earned interest and some of the principal amount.

What is a fixed annuity?

A fixed annuity is an agreement, often with an insurance company, where you provide a sum of money upfront in exchange for a guaranteed amount of income. Certain annuities offer payments for life, while others have a specific payment window.

You can use a fixed annuity to grow your money in an account that is not taxed until a later time. In addition, a fixed annuity may offer a death benefit that works similarly to life insurance, depending on the annuity’s structure.

Similar to CDs, annuities may have penalties if you need to access your money before a certain age. Withdrawing funds from an annuity before reaching age 59 1/2 may result in early withdrawal fees, taxes on your earnings, and the loss of tax-deferred benefits.

Fixed annuities vs. CDs: Rates

The interest rates offered by CDs can be influenced by the decisions made by the Federal Reserve. As of 2023, the Fed has raised the rates multiple times, including seven times in 2022. This has caused an increase in the rates offered by several high-yield CDs in the market.

According to Bryan Bibbo, an advisor at the JL Smith Group in Avon, Ohio, annuity rates have been higher than CD rates in the past. However, before making a decision, it is important to compare the top rates for both CDs and fixed annuities offered by different financial institutions.

Fixed annuities vs. CDs: Security

CDs and fixed annuities share a similarity in that they both provide a guarantee of returning your principal investment along with a specific amount of interest. However, it is important to note that they are backed by different entities for insurance purposes.

If you deposit money in a bank CD that is insured by FDIC, your funds will be protected if the bank fails. Similarly, credit unions have their own deposit insurance through NCUA. Both FDIC and NCUA provide insurance coverage of up to $250,000 per depositor, per insured institution, and per ownership category.

Fixed annuities, which are insured by insurance companies, may not always be backed by financially secure or creditworthy institutions. However, if an insurance company goes bankrupt, another will likely take over. In such cases, annuity holders will receive a minimum guaranteed payout, but their interest rate may be reduced, as per Bibbo.

Bibbo suggests checking the financial stability of an insurance company by analyzing data from two or three credit agencies before investing in an annuity.

Craig Kirsner, a retirement planner and investment adviser representative at Stuart Estate Planning Wealth Advisors, says that insurance companies have a low probability of failing. However, Kirsner’s clients feel more confident about their annuity if it comes from an insurer with an A rating.

Fixed annuities vs. CDs: Taxation

Savers who opt for CDs and enjoy the benefit of a guaranteed rate of return should be aware that they might have to pay higher taxes when it’s time to file.

If you earn interest on a CD, you’ll have to pay taxes every year, whether you can access the money or not. On the other hand, an annuity allows your pre-tax contributions to grow tax-free, and you won’t be taxed until you withdraw the money. If you use after-tax money to contribute, any withdrawals you make will not be taxed.

According to Kelly Crane, senior vice president and financial adviser at Wealth Enhancement Group, if you’re in a higher tax bracket and can wait to access the money, you can benefit from tax-deferred compounding within an annuity.

Fixed annuities vs. CDs: Penalties

Different types of CDs exist, including no-penalty CDs, which do not charge you for withdrawing your money early. Conversely, traditional CDs have an early withdrawal penalty that fluctuates according to the term’s duration and the financial institution administering the account.

According to Bibbo, if you invest in a fixed annuity, you may face surrender charges if you withdraw funds within a certain time frame. With most annuities, you can withdraw up to 10% of the fund per year without penalty. But, if you don’t understand the terms of your contract, you could be charged a penalty for withdrawal.

Making the decision

Deciding where to invest your money for retirement requires careful consideration of various factors. It can be helpful to start by comparing the rates offered on CDs and fixed-rate annuities. However, it’s important to also take into account taxation, fees, and potential penalties. If you’re not well-versed in financial matters, seeking a financial advisor’s help can help determine the most suitable place for your retirement fund.

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