annuities

Turned off by Low CD Rates? Consider a Fixed Annuity

CD rates are under 1%, but comparable annuities can pay more than 2% to 3% guaranteed and tax-deferred.

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.

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.

About the Author

Ken Nuss

CEO / Founder, AnnuityAdvantage

Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Oregon, based company at https://www.annuityadvantage.com or (800) 239-0356.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
The 12 Best Tech Stocks to Buy for 2022
tech stocks

The 12 Best Tech Stocks to Buy for 2022

The best tech-sector picks for the year to come include plays on some of the most exciting emergent technologies, as well as several old-guard mega-ca…
January 3, 2022
How to Know When You Can Retire
retirement

How to Know When You Can Retire

You’ve scrimped and saved, but are you really ready to retire? Here are some helpful calculations that could help you decide whether you can actually …
January 5, 2022

Recommended

Why Women Need to Take a More Active Role in Their Financial Futures
Women & Money

Why Women Need to Take a More Active Role in Their Financial Futures

It’s a mistake to let someone else make all your decisions or take care of everything for you. You can start taking control of your finances by review…
January 17, 2022
What Assets Should Be Included in Your Trust?
estate planning

What Assets Should Be Included in Your Trust?

A revocable living trust is a great tool to help your assets pass smoothly to your beneficiaries, and it can significantly reduce the headaches of pr…
January 16, 2022
Public Defender or Private Attorney: Which Should You Use?
personal finance

Public Defender or Private Attorney: Which Should You Use?

Words of advice from two attorneys about one of the most important decisions you might make.
January 15, 2022
6 New Year’s Resolutions for Your Wealth Plan
retirement planning

6 New Year’s Resolutions for Your Wealth Plan

Everyone could benefit from checking these six items off their to-do list this year.
January 14, 2022