CDs or Annuities: Which Is the Smarter Investment?

certificates of DepositWith interest rates near record lows, it's tough to make your investments generate the income you need. To get the most from your money, you have to make the smartest investments you can.

For conservative investors, bank certificates of deposit are a time-tested favorite for providing income. But many people have discovered that fixed annuities seem to offer similar terms with better rates.

So which investment is the smarter way to get the income you need?

Play it safe, or safer?

Bank CDs are among the safest investments available, as they're federally insured up to $250,000. Even if your bank fails, the FDIC will make your account whole.

By contrast, fixed annuities aren't FDIC-insured even if you buy them at a bank. They are guaranteed by the insurance company that issues them, so it's the company's financial security that determines how safe they are.

There's a risk-reward trade-off, however:
  • Lately, rates on CDs have been extremely low, with one-year CDs paying 1 percent or less. Even five-year CDs fall short of the 2 percent mark.
  • By contrast, fixed annuities offer somewhat better rates. A recent search revealed three-year fixed annuities paying more than 2 percent and longer-term annuities paying 3 percent or more.
The ups and downs of annuities

Annuities come with some other benefits as well. Unlike bank CDs, annuities generate income on a tax-deferred basis, letting you avoid paying tax on the interest until you take the money out of the annuity.

When it comes to getting timely access to your money, annuities and CDs differ. Typically, even if you need to withdraw CD money early, you can simply pay an early-withdrawal penalty equal to three to six months of interest. At 1 percent to 2 percent, that's not usually a huge amount.

On the other hand, many annuities allow you to withdraw a small amount of your money -- often up to 10 percent -- without paying surrender charges, but above that, the cost can be much higher. In addition, if you're younger than age 59 1/2, you'll also have to pay an IRS withdrawal penalty of 10 percent of your interest.

You also have to be careful to understand the guarantees of the particular fixed annuity you choose. Some annuities only guarantee interest rates for an initial period, with rates moving up and down after that. Other annuities guarantee a rate for the entire period.

Which should you pick?

Whether a CD or an annuity is smarter for you depends on your specific financial needs. The key in deciding is to understand that despite looking similar, CDs and annuities are very different. Don't automatically pick an annuity for its higher rates before you understand their features and obligations.

Follow Motley Fool retirement expert Dan Caplinger on Twitter @DanCaplinger.

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The biggest crime is that the Money you invest and payed taxes on is getting 1% interest then when you withdraw you get to pay taxes on the lousy 1% interest again.As much as we pay in Taxes coming and going our country is broke.I gues the top lives on the cream and we can provide it how happy we are.

May 17 2013 at 12:08 PM Report abuse rate up rate down Reply

This article is ridiculously simplistic. The major flaw being that it neglects to distinguish between fixed, fixed indexed, and variable annuities. You can't lump them all into the same bag. They are vastly different products, and have generated vastly different results. Bonuses and guaranteed income base rollups have also been major improvement factors, particularly when it comes to indexed annuities. The author did not do the audience any favors by doing such a lousy job in comparing CD's to annuities.

December 31 2012 at 1:10 PM Report abuse rate up rate down Reply

franzer00 - The typical fixed annuity has no fees at all. Nice try though.

December 22 2012 at 11:30 AM Report abuse rate up rate down Reply

In evaluating annuities, the article sort of shortchanges one factor that can be very important. Yes, there are obligations, but that really means there are lots of fees involved. Banks push annuities, since they make easy money from selling them. Fees can really eat up the value of an annuity, and there may be very limited options for investing within an annuity family.

On the other hand, a CD is a fixed term, so one does not take a long term obligation with one institution.

December 22 2012 at 9:18 AM Report abuse rate up rate down Reply

C.D. Rates aren't at record lows , they are the lowest they've been since Banks offered them. 3 out of 5 Senior's will out live there money. That's deplorable, most of these Seniors lead a very conservitive life being responsible paying all of there bills on time strugiling to save as much as they could so the could retire confortable. Why does't the Goverment help the Seniors like there helping all those BROKE DICKS, with loan forgivness on most of there debts, working with them on there Mortgage payments, which most them haven't paid in years. It's a real shame the way there punishing the ultra responsible Seniors for all that wastfull spending. They could help fix this huge problem by offering a special interest rate for retired seniors over the age of 62 or even 65. 6% too 8% C.D'S would be a good start. The rate depending on their age and the lenth of time when the C.D. mutures. During the Great Deoression from 1929 to 1936 the Goverment offered U.S. Savings Bonds with rates as high as 8% right into the Seventies before we got off the Gold standard. That would be a great start to get us out of the recession in which QE1,2,&3 and operation twist driving interest rates as low as possible can, to encourage borrowing more money. We all seen how wonderful that has worked for the economy. Please get your head out of your ass Mr. Bernake and resign. Believe me you would doing the whole world a big favor.

December 21 2012 at 11:24 AM Report abuse +2 rate up rate down Reply