Fixed Annuities vs Bank CDs (What Are The Differences and Which is Right For You?)

The secret to financial security is to get your money working for you: the more it can earn, the better.

But how should you put it to work?

Investing in stocks is one option. They have the potential to provide large returns, but they’re also risky, and you could end up with less money than you started with.

Two other, much less risky options are annuities and certificates of deposit (CDs). Both are among the safest, lowest-risk products out there, and both can get your hard-earned dollars generating interest for you.

But what is the difference between an annuity and a CD?

CDs are held in banks and are used for short-term investments. They are usually less complex, less flexible, and have lower interest rates than annuities.

Annuities, on the other hand, are issued by insurance companies and are used to provide guaranteed retirement income. They are generally more customizable, and that makes them a little more complex to understand. They typically have higher interest rates than CDs and are better for longer-term retirement planning.

In this article, we explain exactly how annuities and CDs differ from each other. We cover their different interest rates, payout options, tax implications, penalties and fees, safeguards, and guarantees. By the end of this article, you’ll understand the ideal type of investor for each, and which is right for you.

What is an Annuity?

Annuities and CDs are both potentially useful ways for you to grow your money safely. To understand how they’re different, we must first understand each one more clearly.

Let’s start with annuities.

Annuities are contracts issued by life insurance companies. They are used to guarantee a steady stream of income in retirement. And, depending on the payout type you choose, they can provide lifetime income—as in, income for the rest of your life.

Phases of Annuities

There are many types of annuities, but most of them work similarly with two phases.

The first phase is the accumulation phase. This is where you fund the annuity, and your money earns interest over time. Depending on the annuity contract you choose, you may purchase your annuity either in a single lump-sum payment or over a period of time.

The second phase is the payout phase and happens when you annuitize your contract. You receive your initial funds plus the earnings that your annuity accumulated in guaranteed monthly payments for a period of time that you choose.

Note that if you choose an immediate annuity, there is no accumulation phase—the payout phase begins immediately.

Types of Annuities

There are many different types of annuities to meet the needs of different people. The main distinction between annuities is how the rate of return is calculated.

The first type of annuity is one of the most popular: a fixed annuity. With a fixed annuity, the crediting rate has a fixed minimum. That means that the money in a fixed annuity has a minimum guaranteed rate of return over the set period specified in the annuity contract. This makes a fixed annuity ones of the easiest types of annuities

Insurance companies usually give you a higher rate than that minimum, but never lower. Fixed annuities are most comparable to CDs because they both provide a guaranteed interest rate over a set term.

Two other common types of annuities are variable annuities and indexed annuities. The crediting rate for these annuities is tied to the stock market’s performance. That means your annuity’s account value at any given time depends on how well or poorly the stock market (or the particular market index or fund that you select) is doing. Because variable annuities don’t have a guaranteed interest rate, they’re risky, and they often have high fees.

Variable and fixed indexed annuities are not as similar to CDs as fixed annuities. In this article, we only focus on fixed annuities vs. CDs because they have the most in common.

What Is a Certificate of Deposit?

A CD is a savings account housed at a bank, credit union, or other financial institution. With a CD, you invest a given amount of money in the account for a set period of time. Over this period, your money earns a fixed rate of interest. If you keep your cash in the account for the specified term, you receive your money back plus the earnings. But if you withdraw your money before the term is over, you usually have to pay a penalty. Terms can range from as short as 21 days to as long as 10 years.

The most common CDs have terms between 1 and 5 years. CDs are usually a safe way to generate some interest on a lump sum of cash over a relatively short term.

Fixed Annuities vs. CDs: What’s the Difference?

Both fixed annuities and CDs offer a low-risk place to put your money, but they differ considerably from one another.

Primary Purposes

Annuities: Annuities are designed as retirement accounts. Their purpose is to secure a steady stream of income for retirees. They’re for long-term retirement planning.

CDs: CDs are designed as savings accounts. Their purpose is to provide a safe place for your general savings. They’re for short- or medium-term savings planning.

Interest and Crediting Rates

Fixed annuity crediting rates are typically higher than the interest rates for CDs. But rates for both vary considerably.

Annuities: Average annuity crediting rates depend on the type of annuity you choose, the issuing insurance company, and several other factors. The best rates for fixed annuities as of November 2021 for a 5-year term typically sit around 3.25%. Canvas Annuity offers one of the highest rates in the business, with a current 5-year interest rate at 3.25% on the Future Fund annuity. (Check our annuity product page for the most up-to-date rates.)

CDs: CD rates vary depending on the current federal interest rate, the bank or credit union, and the term you select. Generally, the longer the term you select, the higher the interest rate. In November 2021, the highest CD rate for a 5-year term was 0.8%.

As these figures demonstrate, annuity rates are usually much higher than CD rates.

Payouts

Annuities: When an annuity enters the payout phase (also known as the annuitization phase), the annuitant receives the money back plus the earnings. Most people have their annuity paid back to them over time in regular, periodic payments. It is this feature of an annuity that appeals to retirees since one option is to receive payments for the rest of a person’s life. Knowing the amount of future guaranteed income allows retirees to plan out their future spending to match their income.

However, depending on the annuity, it may be possible to receive your annuity payouts in a single lump-sum payment. Keep in mind, because annuities are designed to be used for retirement savings, if you cash out your annuity prior to age 59 ½, you will incur an IRS penalty.

CDs: Once your CD matures (reaches the set term), you can redeem it. To do so, you retrieve your entire principal plus interest in a lump sum. You can cash out your CD at any age.

Taxation

Both annuities and CDs are taxed but they’re taxed very differently. There are two things to consider regarding taxation: taxes on the principal (the amount invested) and taxes on the earnings.

Annuities: All of the money in an annuity grows tax-deferred. In fact, tax deferral may be an annuity's greatest strength. When you withdraw the funds, you may have to pay taxes on the principal, and you will always have to pay taxes on the earnings. Whether you need to pay taxes when withdrawing the principal depends on whether you used pre-tax or after-tax dollars to fund the annuity. In other words, whether you have a qualified or a non-qualified annuity.

Earnings in a fixed annuity grow tax-deferred, but you pay taxes on them when you withdraw them. You pay taxes on withdrawals at your regular income tax rate. Your income tax rate depends on your tax bracket in the year that you withdraw the money.

Since annuities are for retirement, your tax bracket will likely be lower than it was when you put the money in the account. See our guide on annuity taxation for more details.

CDs: A CD's principal isn't taxable because you purchase a CD with after-tax (or non-qualified) dollars—but its earnings are.

Earnings from CDs are taxed as investment income each year. You pay taxes on your CD's earnings even if you don't (or aren’t allowed to) withdraw the money.

Penalties and Fees

Annuities: Insurance companies may charge a fee to purchase a fixed annuity, but the fee is typically very modest. Some products—like the fixed annuities that Canvas annuity offers—don't charge any account fees to open an annuity.

CDs: Banks and credit unions typically do not charge a fee to open a CD.

You usually incur an early withdrawal penalty for both CDs and annuities if you take out your funds before the end of the term. In the annuity world, this is called a surrender charge.

Annuities: If you withdraw from your annuity early, the insurance company often charges you a surrender charge. But keep in mind that products differ; some products, like the Flex Fund at Canvas, are more lenient about when you can withdraw without incurring surrender charges.

CDs: For CDs, banks usually charge a penalty proportionate to the term's interest. For example, if you purchase a 1-year CD, the penalty for early withdrawal might be the equivalent of 3 months' interest. The penalty often nullifies any gains you might have, so it's usually not a good idea to withdraw from your CD before its maturity date. Keep in mind that rules for CDs at some banks are more lenient than others. Always read your contract carefully to understand the fees and penalties that are applicable to your particular CD or annuity.

Security

Both CDs and fixed annuities are among the most secure investment options out there. They both offer guaranteed interest rates for the term that you select.

As long as you don't withdraw your money before the term ends, you're guaranteed to earn interest at the fixed interest rate shown in your contract.

Guarantees

Because of their relative safety, both CDs and annuities are good for the conservative investor or for the portion of anyone's retirement portfolio that they don't want exposed to market losses. 

Annuities: Annuity guarantees are only as good as the insurance company that issues them. That's why it's important to pick a reliable company with a long history (Canvas policies are issued by Puritan Life, an insurer with a long track record of financial stability).

CDs: CDs purchased through a Federal Deposit Insurance Corporation (FDIC)-insured bank are insured up to $250,000. CDs issued by credit unions are similarly insured

CDs vs. Annuities—Which Is Right for You?

So which is right for you—an annuity or a CD?

Here are some things to consider.

• What are your personal finance goals? If you’re looking for tax-deferred growth or to secure a steady retirement income, an annuity is better for you. If you’re looking to save money for everyday use in an account that earns more than a typical bank savings account, a CD may be better.
• When do you want to access the money? If you want the money paid back to you in retirement, choose an annuity. If you need the money sooner, a CD may be more appropriate.
• What kind of interest rate do you want? An annuity will usually provide a higher interest rate than a CD. If you don’t mind a lower interest rate, a CD might be more appropriate for you.

Keep in mind that CDs and fixed annuities are very conservative ways to invest. If you’re looking for more aggressive growth with higher risk, neither of these options may be right for you.

And remember that both annuities and CDs have low liquidity—they lock your money away. If you don’t already have an emergency fund or determine you will need access to your money before the end of the term, you probably want to look at other options.

If you are ready to take your retirement planning to the next level and supplement your social security checks with a steady stream of income, consider a fixed annuity.

Get in touch with our non-commissioned agents and find the annuity product that's right for you.