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| CD or Fixed Annuity, which one is right for you |
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If you're debating whether the best place for your money is a certificate of deposit (CD) or fixed annuity, the answer depends upon your individual investment objectives. Both CDs and fixed annuities are investments used to accumulate wealth. However, these two products are quite different; each has its own unique qualities. For the sake of comparison, let's look at two similar investments; a Non-qualified Certificate of Deoposit issued by a bank and a non-qualified Fixed annuity issued by an insurance comapny. Below is a list of objectives that will help you determine which product is best for you. Goals / Objectives Safety of Principal Both CDs and fixed 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 $100,000 per depositor ($250,000 through 2009). Should the bank fail, the FDIC guarantees CDs up to this amount. Fixed annuities are issued by insurance companies and are not insured by the U.S. government. They are backed by the financial strength of the issuing insurance company, regardless of the amount. Some States such as California has established The California Insurance Guarantee Associations or CIGA (See article, how safe are fixed annuities) to create a secondary form on insurance in the event of insolvency. In California for instance the CIGA will insure each policy up to $100,000 with a $5,000,000 aggregate limit . Nevertheless, before purchasing an annuity, you should make sure the issuing insurance company is financially sound. You can determine financial strength by requesting the findings of independent rating companies such as Moody's, A.M. Best, Standard & Poor's and Fitch. These companies evaluate the financial strength of insurance companies and publish ratings that give their assessments of each company. Short–term Accumulation Deciding upon your investment horizon should be a key factor in determining whether or not to purchase a CD or Fixed Annuity. Your investment horizon is the amount of time you need to save for a specific goal. 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. If you are just "not sure" how long you will need the money a Fixed annuity may prove a better choice due to the liquidity features that annuities provide. Long–term Accumulation Fixed Annuities are generally the product of choice for the long term. Fixed Annuities are designed to help accumulate money for retirement or to protect funds already saved once you've reached retirement. Fixed Annuities generally provide higher rates of interest, longer time frames, tax deferral, and liquidity features that most CD's do not. Interest Return CDs offer a guaranteed rate of return for a specified period of time. Interest rates will vary depending on current market conditions and the length of time to maturity. Generally, the shorter the period of time to maturity, the lower the rate. There is no guaranteed minimum for renewal rates. Fixed Annuities on the other hand offer a guaranteed interest rate that is locked in for an initial period. After that, interest rates may be adjusted periodically, generally each year generally there is a minimum rate established at 2-3%. Tax Savings If taxes are a concern, a fixed annuity can be a great choice! Earnings on CDs are taxable in the year the interest is earned, even if you don't take the money out you will still receive 1099 in the mail.t. Fixed annuities on the other hand, earnings accumulate tax–deferred and are not treated as taxable income until they are withdrawn. This allows you to decide when the best time to pay the taxes will be. If you can imagine a $100,000 investment into a 5 year CD or a 5 Year Fixed annuityy both earning a 5% rate of return. After year one, you have earned $5,000 in interest in both investment. The only problem is that if you are in a 30% tax bracket you owe $1,500 in taxes if you invested in the CD ($5,000 x 30% tax = $1,500) that means your net interest in the CD is $3,500 and your net interest in the Fixed annuity is $5,000. Social Security Fixed annuities may also help reduce or eliminate the taxes on your Social Security benefits. By leaving your money in a deferred fixed annuity, you can reduce your taxable income, keeping it below the level where you would begin to owe taxes on your Social Security benefits. With CDs, your interest earnings count in the calculation of how your Social Security benefits will be taxed — even if you don't withdraw the earnings. As much as 85% of your Social Security benefits could end up subject to taxation. Probate With a fixed annuity you can directly name a benefiicary. That means at death your money will pass directly to your beneficiaries avoiding the costs and hassle associated with Probate. This is not the case with a CD, which may be subject to probate. (Please note, however, that both fixed annuities and CDs are subject to estate tax, and the earnings inside a fixed annuity are subject to income tax when paid out. The earnings in a CD have already been taxed when earned.) Liquidity If you need access to the funds in a CD prior to the maturity date, you may pay an interest penalty and there is generally no gurantee that you will get back your initial investment if surrendered early. A fixed annuity also provides you with access to your money should the need arise. With a deferred fixed annuity, withdrawals during the first several years are generally subject to surrender charges. Most companies will give you the flexibility, however, to withdraw a portion of your deferred annuity's account value, usually 10% each year, without a company–imposed surrender charge. Some companies even offer a Principal Guarantee which means should you fully surrender your contract early you will receive no less than what you put in. Once the surrender charge period has expired, you can generally access your money at any time without surrender penalties. Withdrawals may be taxable and, if they are made prior to age 59½, may be subject to a 10% penalty tax. 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 different maturity period or examine other investment alternatives. With a fixed 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 elect to let your funds continue to accumulate until a need arises. These are just a few of the factors to consider when making your selection between a CD and a fixed annuity. For more information please contact us. |