Annuity vs. CD: Which is the Better Income Source?
There are numerous savings options for retirees, from 401(k)sto IRAs, and even HSAs. But there are other savings vehicles worth considering. A fixed annuity provides retirees with regular payments. But a bank certificate of deposit (CD) or a CD ladder can provide similar benefits.
What is an Annuity?
An annuity is an agreement between the annuity owner and an insurance company. You contribute a set amount to the account in exchange for steady payments at a set date in the future. During the accumulation phase, the annuity owner will fund the account. Then, during the annuitization phase, they will start receiving regular payments.
Annuities can make payments for a set amount of time or for the lifetime of the annuity owner. There are different types of annuities, including fixed, variable, and indexed annuities.
Retirees commonly use annuities as income sources because they have a guaranteed income stream. For example, other retirement savings vehicles don’t automatically make regular payments. However, using an annuity as another savings option can keep retirement funds flush.
What is a CD?
A certificate of deposit is agreement between you and the bank. In this case, you agree to deposit a set amount of cash for a predetermined amount of time. It provides a guaranteed return in exchange for your loyalty. The CD’s interest rate determines the return. Many consider CDs among of the most conservative or safe investments on the market. The bank guarantees the interest rate when you open the CD. Meanwhile, the FDIC insures a CD’s funds for up to $250,000.
A CD ladder divides the amount you’d normally put into a single CD into multiple CDs. By selecting different maturity dates, you’ll stagger your payouts.
CD rates can vary depending on the financial institution offering them. As a result, those rates can affect the amount you stand to earn on a CD. That’s why it’s important to do your research in order to get the best CD rate possible.
Upon maturity of a CD, you’ll receive a lump-sum payment. It will include both the principal (the original investment amount), plus interest earned. Then you have a few options. First, can move the funds into a new CD. Secondly, you can cash out the fund. The latter provides a check for the total balance, paid out in a lump sum.
Annuities and CDs Compared
You can use both annuities and CDs as financial tools while saving for medium- and long-term financial goals. However, there are some important distinctions between the two.
Both CDs and annuities offer a guaranteed return once they hit maturity or enter the annuitization phase. However, they pay out through different means. For example, annuity owners receive regular payments once they enter the annuitization phase. Meanwhile, CD owners only receive a payment once their CD matures.
However, you may invest in a CD ladder instead of a single CD. In that case, the differing maturity dates of each CD offer semi-regular payments from your CDs. By offering payments instead of a lump sum, a CD ladder is similar to an annuity.
Which is Right for You?
Generally speaking, CDs can help save for medium-term goals with little risk. That may includ a house down payment. Meanwhile, annuities can offer an additional income stream in retirement.
Remember, CDs offer one lump-sum payment once the CD matures, which means you can put money away relatively risk-free, then access it at the predetermined date of maturity. CD ladders are when you invest in CDs with staggered maturity dates so that you receive the lump sum payouts in a staggered fashion.
Annuities, on the other hand, dole out regular payments once they hit the annuitization phase, either for a predetermined amount of time or for the rest of the life of the annuity owner.
Meanwhile, the IRS taxes annuities and CDs differently. A CD’s principal balance doesn’t face taxes, though interest earned does.
How the IRS taxes annuities depends on how they are structured and funded. Annuities funded with pre-tax dollars are taxed upon withdrawal of funds. If you used after-tax dollars to fund your annuity then a part of your payout will be tax-free return of the principal. In either case, annuity taxes will be at your income tax rate, not the lower capital gains tax rate.
The Bottom Line
Both annuities and CDs are savings vehicles that offer a guaranteed return, but the best option for you depends on your financial goals. If you want to set aside money for medium-term financial goals with little market risk, a CD may be your best bet. But if you want to add an additional income stream in retirement to avoid outliving your assets, an annuity is a better option.
Savings Tips
If you’re not sure where CDs and annuities fit into your portfolio, a financial advisor may be able to help. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
Is this the year you get serious about saving? Do you know what kind of interest you’ll need to help your savings along? Can you separate the good savings accounts and vehicles from the not-so-great ones? If you’re just looking for a little help with saving, SmartAsset’s checking and savings guide can point you in the right direction.
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