The difference between a CD and a fixed deferred annuity

While both CDs and fixed deferred annuities are good savings vehicles, it's important to identify your goals to determine which option is best for you.

CD vs. annuity: Which one works best for you?

Both certificates of deposit (CDs) and fixed deferred annuities can be used to accumulate wealth. However, there are many differences between them. Let’s compare two similar versions of these products:

1. An individually owned, nonqualified bank CD. 
2. An individually owned, nonqualified single-premium deferred fixed annuity.

Carefully review the following comparisons to help you decide which of these two products best suits your needs and financial situation.

Safety of principal

Both CDs and fixed deferred annuities are considered low-risk investments. CDs are generally issued by banks and, in most cases, are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor. Should the bank fail, the FDIC guarantees CDs up to this amount.

Fixed deferred annuities are issued by insurance companies and are not insured by the U.S. government. They are backed by the claims paying ability of the issuing insurance company, regardless of the amount.

Before purchasing an annuity, you should make sure the issuing insurance company is financially sound. You can request the findings of independent rating companies such as Moody’s, A.M. Best, Standard & Poor’s, and Fitch.

Short-term accumulation

When deciding between a CD and a fixed deferred annuity, the amount of time you need to save should be a key factor. For short-term goals, such as a down payment on a home or a new car, a CD may prove to be a better choice. CD maturity periods can be as short as one month or as long as several years.

Long-term accumulation

A fixed deferred annuity is designed to help you accumulate money for retirement, or to protect the funds you’ve already saved once you’ve reached retirement. A fixed deferred annuity is usually more flexible for accessing your money later.

CD vs. annuity: Key objectives

Interest return

CDs offer you a guaranteed rate of return for a specified period; interest rates will vary depending on market conditions at the time the CD is purchased and the length of time before the CD’s maturity, but they are usually fixed for the entire CD term. There is no guaranteed minimum for renewal rates.

With a fixed deferred annuity, a guaranteed interest rate is locked in for an initial period. After that, interest rates may be adjusted each year. Fixed deferred annuities also provide you with a guaranteed minimum interest rate, regardless of market conditions.

Tax savings

If taxes are a concern, a fixed deferred annuity may be a better option.

Earnings on CDs are taxable in the year the interest is earned.

With fixed deferred annuities, earnings accumulate tax deferred and are not treated as taxable income until they are withdrawn. This could help come tax-return time. If you are saving for the long term like for retirement, the tax deferral may be helpful.

Fixed deferred annuities may also help reduce or eliminate taxes on your Social Security benefits. If you leave your money in a fixed deferred annuity, you may be able to reduce your taxable income, keeping it below the level where you would begin to owe taxes on your Social Security benefits. (In 2020, couples filing jointly with income below $32,000 a year owed no taxes on their Social Security benefits, couples with income between $32,000 to $44,000 owed taxes on 50 percent of their Social Security income, and couples with income of more than $44,000 owed taxes on 85 percent of their Social Security income.¹)

Your interest on a CD is taxable, so it will add to your income for the year. With an annuity, your interest isn’t taxable until you withdraw the money, so it won’t count as income that may cause your Social Security payments to be taxed—until it is withdrawn.

Additionally, your annuity’s account value will be paid directly to your named beneficiaries, avoiding the costs and delays associated with probate. A CD may be subject to probate. Note, however, that if an estate is sufficiently large, both fixed annuities and CDs are subject to estate taxes. Note, also, that the earnings inside a fixed annuity are subject to income taxes when they are paid out. (The earnings in a CD, by contrast, are taxed when you earn them.)

Liquidity

If you need access to the funds in a CD prior to its maturity date, you may pay an interest penalty ranging from 30 days to six months of interest.

A fixed deferred annuity also provides you with access to your money; however, withdrawals taken during the surrender charge period are generally subject to surrender charges. Most companies will allow you to withdraw a portion of your deferred annuity’s account value, usually 10% each year, without a company-imposed surrender charge.

Once the surrender-charge period has expired, you can access your money at any time without surrender penalties. It’s important to remember that such withdrawals will be taxable and, if made prior to age 59½, may be subject to an additional 10% tax penalty.

Distribution options at maturity

When a CD reaches its maturity, you can take the CD’s lump-sum value in cash, renew the CD for the same or for a different maturity period, or examine other savings alternatives (such as a fixed deferred annuity).

With a fixed deferred annuity, you may elect to withdraw your money in a lump sum, or you may want to select a lifetime income option, which provides you with a flow of income that you cannot outlive. You could also choose to let your funds continue to accumulate until they are needed.

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¹Source: https://www.irs.gov/newsroom/dont-forget-social-security-benefits-may-be-taxable Neither New York Life Insurance Company nor its agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.