Covering the differences between a bank CD and a fixed annuity.
For those looking for low risk investments focused on safety of principal coupled with reasonable returns often times find themselves torn between purchasing either a CD or an Annuity. As both offer safety of principal there are a few things to consider before deciding which will best suit your financial needs.
Annuity / CD Overview
Annuities are typically offered by insurance companies and sold as financial products. Generally a client would give the insurance company a lump sum of money or annuity premium which would then be invested by the insurance company. The insurance company in return guarantees the client either a fixed rate of return for a set period of time which would then be available to the client upon the maturity of the contract, or guarantees a steady flow of income for either a set period of time or for the lifetime of the contract holder.
CD’s are considered to be a type of financial arrangement between the CD holder and a financial institute, often times they are offered through a bank. The holder of the CD deposits a sum of money with the financial institute at which point the money will grow at a predetermined interest rate for the duration of the contract. At the end of the CD’s contract the client can then withdraw their original principal plus the prearranged interest that was earned during the life of the contract.
Advantages to Owning an Annuity:
The most glaring difference between CD’s and annuities is that annuities will usually offer much higher returns than with a typical CD. Annuities also have the ability to provide a steady stream of income for either a set period of time or with optional income riders can provide a stream of income that can never be outlived. Income streams are typically not available with CD’s. Another huge advantage for annuities is their ability to grow tax deferred. Compared with traditional CD’s where the holder would receive a 1099 each year on the interest gained.
Advantages to Owning a CD:
One of the biggest advantages to owning a CD is the overall safety of them. Because they are considered savings vs investments they are covered by federal deposit insurance, whereas with annuities their guarantees are generally as good as the strength of the insurance company providing them. This is why it is important to always purchase annuities from insurance companies with high financial ratings.
Because CD’s are considered such a safe investment they usually offer lower interest rates then traditional fixed annuities. An important thing to remember with both annuities and CD’s is that if an individual were to decide to cancel or surrender the contract prior to the maturity date both can be subject to penalties or surrender charges.
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