written by: ShawnTe•edited by: Jean Scheid•updated: 5/13/2010
Annuities and certificates of deposits are investment products many use to plan for their retirement. Here, you'll discover what each product is, their similarities, and the difference between annuities and bank CDs.
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Saving for retirement seems like a simple enough task at first glance. However, when you are presented with the various types of investment options available for retirement planning, the task seems less simple. Two retirement investment options are annuities and certificates of deposit (CD). Both options are a way to plan for retirement, but what is the difference between annuities and bank CDs?
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Certificates of Deposit
Certificates of deposit or CDs are deposit accounts used as a type of savings investment. CDs are often used as a way to save for retirement that preserves the principal investment. Since CDs are deposit accounts, the Federal Deposit Insurance Corporation (FDIC) insures them up to $250,000.
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An annuity is a type of retirement investment purchased from an insurance company that can be paid in a lump-sum payment or in installments. The insurance company gives you the option to receive your investment back immediately or at a future date. You also have the option to have the investment paid back in one lump payment or periodically over a set number of years.
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How are Annuities and CDs Similar?
Besides being retirement investment products, annuities and bank CDs have other similarities. Both are interest-bearing investments that are tax deferred until payments are made to you. This means that while interest is accruing, you do not need to pay taxes on it; only when interest is paid to you are taxes due to the IRS.
Annuities and bank CDs can offer fixed rates for the life of the investment. What this means is that your interest rate will be a flat rate and your payments will be the same amount until the final payment is made to you. Both annuities and CDs come in various types beyond fixed rates, including variable versions of these retirement products; however, there is a difference between variable annuities and bank CDs that have a variable rate.
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Annuities vs. Bank CDs
Annuities and bank CDs, while both are retirement investment products, exist in different categories. Annuities are an insurance product issued by an insurance company. Bank CDs are deposit accounts issued by banks.
Annuities can last for a predetermined length of time such as twenty years or they can last for the lifetime of the investor. Some annuities include a death benefit where the beneficiary is guaranteed a specific, minimum amount (typically the total purchase payments made). CDs have a minimum term of seven days and often have terms as long as 30 years. Early maturity is available for bank CDs but this often comes with a monetary penalty, usually taken from the interest via a lowered interest rate.
A variable annuity is not considered variable based upon the interest rate alone. This type of annuity is directly linked to the performance of different investment options, typically mutual funds in your portfolio. The rate of return and amount of your payments will fluctuate based upon the performance of your selected investment options. Variable CDs have a variable or floating interest rate that can yield high returns when the rates are high and meager ones when rates hit bottom.
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These similarities and differences between annuities and bank CDs are some of the basic ones individuals may notice that will immediately affect their decision to invest in one over the other. A financial planner or analyst can discuss specific types of annuities and bank CDs in detail with you. By learning the basic differences between annuities and bank CDs, you will have a basic knowledge to take with you when you begin searching for the right retirement investment for your future.
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Investopedia. (2008). Investopedia. Retrieved May 10, 2010, from Investopedia: www.investopedia.com
U.S. Securities and Exchange Commission. (2005, July 19). Annuities. May 10, 2010, from U.S. Securities and Exchange Commission: http://www.sec.gov/answers/annuity.htm
Image Credit: US Postal Savings System / Wikimedia Commons
Understanding the retirement product called annuities. Learn the difference between annuities and bank cds; are annuities safe investments; the pros and cons of fixed annuities; along with the strengths and weaknesses of variable annuities.