||Ask Dr. Don
Annuities vs. CDs
Please explain to me what an annuity is and the pros and cons of
having money invested in an annuity. I was told by my banker that
if I put money into an annuity that I would earn more interest than
I would by investing in CDs at this time.
A fixed annuity is a contract between you and an insurance company
for an investment that has guaranteed income options and a life
Insurance agents, stockbrokers and financial institutions
all sell annuities, so they are widely available. The insurance
company credits interest on the investment, but you don't pay taxes
on the interest until you surrender the annuity or begin to receive
income from the annuity investment.
There is a special class of fixed annuities called
CD-Type annuities. These annuities are different than the typical
fixed annuity because the period of the guaranteed interest rate
is equal to the length of time that the surrender charge period
exists. If the surrender charge falls off at the same time that
the interest rate guarantee falls off, the investor can switch to
another investment without paying surrender charges. (There are
still tax implications.)
Most fixed annuities offer a guaranteed interest rate
for a duration that is less than the number of years that the surrender
charge applies. After the guaranteed interest period expires, the
insurance company then declares the new interest rate for that policy
year. The "renewal rate" will usually be lower than the
initial guaranteed interest rate.
CDs don't have the tax-deferral features of a fixed
annuity, but annuities don't have the backing of FDIC insurance.
That's not to say that annuities aren't safe. Insurance
companies are rated for safety, and you can limit your annuity investing
to insurance companies with the highest ratings.
CDs have interest penalties for early withdrawal and
fixed annuities have surrender charges. As a tax-deferred investment,
withdrawals from a fixed annuity can trigger an IRS penalty tax
when money is withdrawn prior to age 59½.
If you're investing for retirement and looking to
lock in longer-term rates, an annuity can be more attractive than
a CD. For other financial goals and shorter investment horizons,
you'll be happier with a CD vs. a fixed annuity.
Shop the best CD
rates on Bankrate and check out CD-type fixed annuities on Annuity.com.
You'll also want to read Pat Curry's recent article for Bankrate,"Why
annuity sales have skyrocketed."
-- Posted: Sept. 27, 2001