CD or Annuity? Key Differences Explained
In order to understand the key differences between CDs and annuities, it’s worth reminding yourself how they work.
What is a CD?
A CD is a financial product offered by a bank. When you take out a CD, you agree to leave your money in one place for a set period of time. In exchange, your bank or credit union will pay you a set interest rate on this money, one that is typically higher than other types of savings accounts. The downside is that your money isn’t liquid—you have to leave it in the CD for the whole term you’ve agreed to or you’ll have to pay early withdrawal penalties.
What is an Annuity?
An annuity, in contrast, is essentially an insurance contract.
Annuities generally pay a higher interest rate than a CD. This is because the financial institution you hold your annuity with is exposed to less risk with an annuity due to the longer length of time you will hold it.
Since federal interest rates are rising rapidly, along with inflation, a difference of just 1% or 2% can affect the long-term return on your investments significantly and help you outpace inflation. This can make an annuity a good option for pre and post retirees who are in need of a higher return to offset distributions and who want to keep their investments low-risk.
What about taxes?
The final difference between annuities and CDs is the tax implications of each investment instrument.
Annuities are designed to be used for retirement and come with tax advantages when used in this way. The interest that your annuity earns is tax-deferred and so you pay taxes only when you start taking withdrawals from the annuity unless it is funded with Roth IRA money, then it is tax free. Withdrawals are taxed at the same tax rate as your ordinary income. If you fund an annuity through a Traditional Individual Retirement Account (IRA) or another tax-advantaged retirement plan, you may also be entitled to a tax deduction for your contribution. This is known as a qualified annuity.
In contrast, the money you earn through a CD will be taxed as income when the CD matures and you are paid your lump sum. This can make annuities more tax-efficient than CDs, but for most people, the other differences between these investment instruments will be more important than the tax implications of each.
The More You Know.
Source: https://www.investopedia.com/cds-vs-annuities-5235446#:~:text=Annuities%20will%20generally%20pay%20a,long%2Dterm%20investment%20for%20retirement.
