It’s impossible to turn on the news without hearing fresh reminders of the turmoil in the markets and the broader economy. In this uncertain climate, many people are anxious to try to find a safe place for their savings.
Two popular options are certificates of deposit and deferred fixed annuities. Both are considered low-risk vehicles for building wealth, yet they differ in important ways. Which choice is better depends on a person’s goals and priorities. Here’s a comparison of these investment vehicles.
Principal safety
Both CDs and deferred fixed annuities are considered low-risk investments.
CDs are generally issued by banks and, in most cases, are insured by the Federal Deposit Insurance Corp. for up to $250,000 per depositor. Should the bank fail, the FDIC guarantees CDs up to this amount.
Deferred 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. Therefore, before purchasing an annuity, it’s important to make sure the issuing insurance company is financially sound.
Financial strength can be generally determined 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.
Length of investments
When saving toward a specific near-term objective — say, a down payment on a car or home — a CD may be the way to go. CDs offer a guaranteed interest during a maturity period that could range from a month to few years.
Deferred fixed annuities, by contrast, are generally designed for accumulating or protecting retirement savings. In later years, they usually offer more flexibility for access to the funds and can be used to provide a legacy for heirs.
The major reason for considering the investment timeframe is the surrender charges that may apply to either a CD or a deferred fixed annuity. In both cases, early surrender can eliminate most or all of the interest paid. In some situations, part of the principal also can be at risk. Deferred fixed annuities, however, may offer surrender-charge-free windows of 10 percent or more.
Annuities have a reputation for high fees in some circles, but in the case of deferred fixed annuities, the interest rate stated is the rate paid with no hidden charges, so it is easy to compare one annuity to another or to other investments.
Distribution and taxes
When a CD reaches its maturity, the CD’s lump sum value can be taken in cash, and the CD can be renewed for the same or different maturity period. If not, other investment alternatives can be examined.
In a deferred fixed annuity, money can be withdrawn in a lump sum or paid as a guaranteed income stream, a flow of income that cannot be outlived. It is also possible to allow funds to continue to accumulate until a need arises without incurring a new surrender-charge period.
For taxes, federal law treats these two savings options quite differently. If taxes are a concern, a deferred fixed annuity may be the more attractive choice. CD earnings are taxable the year the interest is earned, even if the money isn’t withdrawn at that time. In contrast, earnings from deferred fixed annuities are not taxed until they’re withdrawn, giving some control over when – and how much – and how much taxes are paid.
Clearly, there are pros and cons to both types of investments. Financial advisers can help investors determine which option fits best with individual portfolios.
Rob Hendrickson is a financial adviser in Springfield with Eagle Strategies LLC, a wholly owned subsidiary of New York Life Insurance Co. He may be reached at hendricksonr@eaglestrategies.com.[[In-content Ad]]
