Annuity vs. CD: How They Compare

When choosing a safe place to grow your money, annuities and certificates of deposit (CDs) are two popular options. Both offer a way to earn interest with minimal risk, but they have different purposes and distinct features.

In this article, we break down the key differences so you can make a choice that aligns with your financial goals.

What’s an annuity?

An annuity is a financial product designed to provide a steady income stream — usually for retirement. It’s essentially a contract between you and an insurance company where you pay a lump sum or a series of payments in exchange for periodic payouts, either immediately or in the future. People typically choose annuities when they want reliable income to supplement their retirement savings.

There are different types of annuities:

• Fixed annuities provide guaranteed payouts at a set interest rate.
• Variable annuities base your payout on market performance.
• Indexed annuities combine features of both fixed and variable annuities. While they offer a guaranteed minimum interest rate, they also offer returns based on a market index, like the S&P 500. This gives you the potential to earn more than a fixed annuity, but exposes you to more risk as well.

Annuities also offer tax-deferred growth, meaning you won’t pay taxes on earnings until you start receiving payments. This can be beneficial if you want to grow your savings over time without taxes eating away at your investment returns.

However, annuities typically come with fees, such as administration costs or surrender charges, so you should weigh the cost versus the benefits when evaluating them as an investment.

What’s a CD?

A CD is a type of savings account offered by banks and credit unions. It typically provides a fixed interest rate over a specified period. When you invest in a CD, you agree to leave your money with the bank for a set term, ranging from a few months to several years. In return, the bank pays you interest — usually at a higher rate than a traditional savings account.

One of the main benefits of a CD is its safety. CDs are generally low-risk investments because they’re insured by either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) up to $250,000 per depositor, per financial institution. This guarantees that your money is protected, even if the bank fails.

However, the tradeoff for this safety is limited liquidity. With most CDs, you’ll face early withdrawal penalties if you need to take your money out before the term ends. Further, in a rising interest rate environment, locking your money into a long-term CD could mean missing out on higher returns you might earn elsewhere (though the flipside is also true, as a CD can allow you to lock in a higher rate when rates are poised to fall).

Annuity vs. CD: How they’re similar

At first glance, annuities and CDs might seem quite different, but they share some characteristics that make them attractive to conservative investors. Here’s how they’re similar:

• Low-risk investment options. Annuities and CDs are low-risk investments. While the FDIC and NCUA insure CDs, the insurance guarantee fund in each state covers annuities, providing at least $250,000 of annuity benefits for customers. Both CDs and annuities are good options for preserving principal while generating an investment return.
• Fixed interest rates. Fixed annuities and CDs typically offer the benefits of fixed interest rates, so you know exactly how much you’ll earn over the term of the investment. With both products, market fluctuations don’t impact your return. That’s a key feature for people seeking predictable returns.
• Penalties for early withdrawals. If you need to access your funds before the agreed-upon term ends, both annuities and CDs impose penalties. For CDs, this usually comes in the form of an early withdrawal penalty that reduces your earned interest. Meanwhile, annuities often have surrender charges if you withdraw your money too soon, especially within the first few years.

Annuity vs. CD: How they’re different

While annuities and CDs share some similarities, they differ in several important ways. Understanding these differences can help you choose the right investments to meet your financial goals. Here’s how they differ:

• Investment duration. One key difference between CDs and annuities is the length of the investment. The terms on CDs usually range from a few months to a few years. Annuities, on the other hand, can span decades, especially if you’re looking for a lifetime income. This makes annuities better suited to long-term financial goals like retirement, while CDs are better for short-term savings.
• Payout structure. With CDs, interest might be credited to your account monthly, but you collect your principal and interest at the end of the term in a lump sum. Annuities, however, offer more flexibility in payout options. Depending on the type of annuity you choose, you might receive a lump sum or periodic payments for a set number of years or the rest of your life.
• Tax treatment. The returns you earn from CDs and annuities are both taxable as regular income, but they aren’t taxed the same way. Interest earned on a CD is taxable as regular income in the year it’s paid, even if you don’t withdraw the funds. Annuities benefit from tax-deferred growth, meaning you won’t pay taxes on earnings until you begin receiving payments, usually in retirement.

Is a CD or annuity for me?

Whether you should choose a CD or an annuity depends on your financial goals and timeline. If you’re looking for a short-term, low-risk way to grow your money with easy access after a few months or a few years, a CD may be a better fit. CDs provide guaranteed returns and are low-risk, making them a solid choice for short-term savings goals. That said, you can stretch out your yields with a CD ladder, where you invest in multiple CDs with staggered maturity dates.

On the other hand, if you want a steady stream of income in retirement, an annuity might be the right choice. Their long-term growth potential and tax-deferred earnings can help you plan for a reliable income later in life. However, they do require a longer term commitment and often come with higher fees.

If you decide to buy an annuity, make your purchase from a registered insurance broker. Not all brokers are licensed to sell annuities in every state, so check with your state’s insurance commission or FINRA’s BrokerCheck to confirm that your broker is properly registered. This helps ensure you’re working with a reputable professional.

In addition, before committing to an annuity, check out the financial strength of the insurance company offering the annuity. AM Best is a trustworthy source for evaluating the financial stability of insurance companies. Working with a company rated A or better can give you peace of mind that the company will be able to meet its long-term payout obligations.

Meanwhile, before opening a CD, it is important to shop around for the best CD rates. You should also consider how long you are comfortable keeping your money tied up, and make sure you understand any early withdrawal penalties involved.