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Banking & Finance

2011-04-01 10:42:00

CDs vs. annuities: Where should you invest your money?

Question: Can you explain the differences between a CD and an Annuity? Which is better long term?

Answer: If you’re quickly approaching retirement, you’re probably asking yourself an all-too-common question: should I invest in a bank CD or an annuity? You’re not alone. Consumers across the nation are struggling with the same dilemma. The first step in making this important decision is to understand the differences between these two products. Annuities and CDs (short for bank certificates of deposit) might appear to be very similar at first glance. Both are secure, low risk investments that are designed to help you accumulate wealth. However, these two types of investments are actually very different products. First of all, CDs are generally issued by banks while annuities are offered by insurance companies. Secondly, a CD is typically a better investment for short-term goals, such as a down payment on a new home or car, while an annuity is a better choice for longer term goals, like generating a lifetime stream of retirement income. Here are a few things to keep in mind as you weigh the differences between CDs and annuities: CD interest rates are uncertain Interest rates have plummeted in recent months. While that’s a great thing for homebuyers, it translates into lower returns on bank savings. Right now, one-year CDs often pay 1.5 percent or less—a huge drop from a couple of years ago when CDs paid more than 3 percent. The future is uncertain for CD interest rates. Your rate on a CD may be higher or lower a year from now—it’s too hard to predict. So, if you’re looking to maintain a certain retirement income level, a CD may not be the best bet. Guaranteed rates with fixed annuities Fixed annuities offer a guaranteed minimum. This ensures that your investment will not drop below the minimum performance. When interest rates drop, so do returns on CDs. But fixed annuity returns never fall below a certain point. Therefore, if you hold a fixed annuity until maturity, you are guaranteed to earn a minimum stated rate of interest regardless of what happens to interest rates or stock market indexes. Because fixed annuities are lower risk, conservative investments, they are often ideal for retirees or soon-to-be retires. Fixed annuities offer incredible tax advantages With CDs, you must pay taxes annually on the interest earned even if you haven’t withdrawn any money. Alternatively, fixed annuity earnings are tax-deferred. You only pay taxes on interest earned when you withdraw money from the annuity. This means that you end up earning an increasing amount of money with fixed annuities because the deferred tax on your interest remains in the investment instead of being paid out to state and federal taxes each year. CDs aren’t as flexible Fixed annuities also offer more flexibility than CDs. With a CD, you cannot remove any money before the term is over without incurring an early withdrawal penalty. Although fixed annuities also have early withdrawal penalties known as surrender charges, they include provisions that typically allow you to withdraw 10% of your investment value each year without penalties. Additionally, with many fixed annuities, you can withdraw the earned interest on your investment each month. Some fixed annuities offer you access to the sum total of your investment funds in the event of a financial hardship. For example, you may be allowed to withdraw from your fixed annuity penalty free if you are hospitalized, develop a life-threatening illness or are forced to live in a nursing home for an extended length of time. With a fixed annuity, you can also choose an option to receive a predetermined amount of income from the investment over a fixed time period, such as five or ten years. This option offers enhanced income security while spreading out any taxes that your earnings might incur over many years. Annuities are extremely safe While CDs are issued by banks, annuities are issued by insurance companies. As compared to banks and brokerage firms, insurance companies have a historical record of stability. This is largely because insurance companies offer conservative investment options that carry very little risk. Just think...insurance companies have survived times of war, global depressions, government failures, industry scandals and disastrous stock market plunges. However, in even the worst of times, Americans have been able to safely insure their homes, health, life, cars and businesses. Survey says… All things considered, fixed annuities are a solid option for retirement-focused investors. These superior, reliable investments can provide higher returns, tax advantages and enhanced flexibility, all while providing safety and security. Not to mention that fixed annuities can generate a guaranteed stream of income. Talk to your financial advisor or insurance agent today about whether a fixed annuity is right for you.