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Ask Dr. Don

Annuities vs. CDs

Dr. Don,
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.
Londa Lowdown

Dear Londa,
A fixed annuity is a contract between you and an insurance company for an investment that has guaranteed income options and a life insurance component.

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.

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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 As a tax-deferred investment, withdrawals from a fixed annuity can trigger an IRS penalty tax when money is withdrawn prior to age 59½.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

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