Rates on bank certificates of deposit are dismal. The best you can do as of early November 2020 is a mere 0.65% for a one-year CD, 0.85% for a three-year CD, and 1.00% for a five-year certificate, according to Bankrate.com.
While you’re certain to get your money back, because CDs are insured by the FDIC, you’re also virtually certain to lose money after inflation and taxes.
There’s a better way to save money for many people. It’s a fixed-rate annuity — also known as a multi-year guarantee annuity or a CD-type annuity. You can earn up to 2.40% for a three-year fixed annuity and up to 3.05% annually for a five-year contract, according to AnnuityAdvantage’s large database of annuity rates.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Like a CD, a fixed annuity pays a guaranteed interest rate for a set period, usually three to 10 years. There’s no sales charge, so all of your money goes to work for you immediately. The interest is tax-deferred.
While annuities are not FDIC-insured, they are covered by state guaranty associations, up to certain limits, which vary by state. While this is a valuable backstop, the odds that you’ll ever need to rely on the guaranty association are very small. Annuities are issued and guaranteed by life insurance companies, which are strictly regulated by the states to ensure their solvency. This system has worked well.
Besides higher rates, here are the additional ways fixed-rate annuities beat CDs.
Tax-deferral. All CD interest is subject to federal and state income tax annually, even when it’s reinvested and compounded in the CD (unless the CD is in an IRA or other retirement account).
A fixed annuity, on the other hand, is tax-deferred. You won’t receive an annual 1099 and you won’t pay tax on the interest until you withdraw it. At the end of the annuity’s initial guarantee period, you may renew it for another term or roll it over into another annuity.
Tax deferral isn’t an advantage when you hold an annuity in an IRA or other retirement account. However, since you get a guaranteed, competitive rate, a fixed annuity is still a top choice for the portion of your retirement-plan assets you want to shelter from stock-market risk while earning an attractive rate of interest.
For certain retirees, lower taxes on Social Security benefits. About 40% of retirees who receive Social Security pay taxes on at least a portion of their benefits. By moving some of your money from a CD into an annuity, you’ll reduce income that may trigger the tax on Social Security benefits.
Most people who are taxed on their Social Security benefits will profit from this strategy, but not high-income retirees who are well past the threshold. Consult the Social Security website (www.ssa.gov/benefits/retirement/planner/taxes.html) to see how you may be taxed and whether this strategy may work for you.
Greater unpenalized liquidity. Banks impose substantial penalties on all early withdrawals from CDs. Most fixed-rate annuities let you withdraw interest or up to 10% of the value annually without penalty. You will owe income taxes on any interest withdrawn.
Continuing tax deferral and flexibility. Once the fixed term is up, you may renew or can roll over the proceeds into a new annuity of any type and continue to postpone taxes. When you get closer to retirement, you may decide to annuitize the contract. That means you would convert the fixed annuity into an income annuity. You will get a guaranteed lifetime monthly income that begins either immediately or at a future date you select.
One disadvantage vs. CDs. If you withdraw money from your annuity before age 59½, you’ll owe the IRS a 10% penalty on the interest earnings you’ve withdrawn, plus regular income tax on it, as you would at any age. If you’re sure you won’t need the money in the annuity before that age, you’re good to go. If not, it might be wiser to delay purchasing one until you’re older.
This caution doesn’t apply to a fixed annuity in an IRA since you normally won’t take money out of an IRA until you’re past 59½ anyway.
-
These Stocks Dipped in 2025. Do They Have Value?If you are looking to add new long-term positions to your portfolio, as you should, this is the time to examine stocks that the market shuns.
-
Striking Gold (or Gas): A Financial Pro Unpacks the Nuances of Energy InvestingInvesting in the energy industry, particularly oil and gas, involves understanding the facts about how projects generate returns through cash flow and long-term asset building, while also being aware of the risks.
-
Striking Gold (or Gas): A Financial Pro Unpacks the Nuances of Energy Investing
Investing in the energy industry, particularly oil and gas, involves understanding the facts about how projects generate returns through cash flow and long-term asset building, while also being aware of the risks.
-
Escaping the New Golden Handcuffs: A Financial Expert Has a Plan for Today's ExecutivesFeeling stuck in your job? It could be your complicated compensation package, but it also could be where you live, your family or even how you view yourself.
-
I'm a Financial Planner: Here's How to Invest Like the Wealthy, Even if You Don't Have MillionsPrivate market investments, once exclusive to the ultra-wealthy and institutions, have become more accessible to individual investors, thanks to regulatory changes and new investment structures.
-
Four Ways a Massive Emergency Fund Can Hurt You More Than It HelpsSaving too much could mean you're missing opportunities to put your money to work. Redirect some of that money toward paying off debt, building retirement funds, fulfilling a dream or investing in higher-growth options.
-
I'm a Financial Planner: How to Dodge a Retirement Danger You May Not Have Heard AboutTiming is everything, and sequence of returns risk can mean the difference between a retirement nest egg that's overflowing … or empty.
-
Caring for Aging Parents: An Expert Guide to Easing the Financial and Emotional StrainEarly conversations, financial planning and understanding the progression of care needs can help to mitigate stress and protect family relationships.
-
I'm a Financial Adviser: The OBBB Is a Reminder for Older People to Have a Long-Term PlanThe new tax bill presents a good opportunity for retirees to revisit tax plans, look into doing some Roth conversions and consider plans for long-term care.
-
I'm an Insurance Expert: This Is Exactly Why Your Insurance Rates Are Soaring (and What You Can Do)A dramatic rise in the frequency and cost of severe weather and wildfires means you need to prepare, prepare, prepare — no matter where you live — for higher premiums.
