Why Fixed-Rate Annuities Pay More than Bank CDs
Have you looked at the interest rates CDs pay lately? If you’re underwhelmed, you may want to look into a fixed-rate annuity. Each has distinct pros and cons, so compare before investing.
You are now subscribed
Your newsletter sign-up was successful
Want to add more newsletters?
Delivered daily
Kiplinger Today
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more delivered daily. Smart money moves start here.
Sent five days a week
Kiplinger A Step Ahead
Get practical help to make better financial decisions in your everyday life, from spending to savings on top deals.
Delivered daily
Kiplinger Closing Bell
Get today's biggest financial and investing headlines delivered to your inbox every day the U.S. stock market is open.
Sent twice a week
Kiplinger Adviser Intel
Financial pros across the country share best practices and fresh tactics to preserve and grow your wealth.
Delivered weekly
Kiplinger Tax Tips
Trim your federal and state tax bills with practical tax-planning and tax-cutting strategies.
Sent twice a week
Kiplinger Retirement Tips
Your twice-a-week guide to planning and enjoying a financially secure and richly rewarding retirement
Sent bimonthly.
Kiplinger Adviser Angle
Insights for advisers, wealth managers and other financial professionals.
Sent twice a week
Kiplinger Investing Weekly
Your twice-a-week roundup of promising stocks, funds, companies and industries you should consider, ones you should avoid, and why.
Sent weekly for six weeks
Kiplinger Invest for Retirement
Your step-by-step six-part series on how to invest for retirement, from devising a successful strategy to exactly which investments to choose.
Fixed-rate annuities act much like bank certificates of deposit but usually pay much higher rates than CDs of the same term.
How can insurers afford to do that? After all, both banks and insurers pay a set rate. Before we answer that question, let’s cover the basics of how each works.
A very popular type of fixed annuity, the multi-year guarantee annuity, pays a guaranteed rate of interest for a period of two to 10 years. There’s no sales charge. This is why they’re often referred to as “CD-type annuities,” but there are key differences between them and CDs.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
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.
Annuities vs. CDs: Taxation, Penalties and Liquidity
One is taxation. As long as you reinvest annuity interest and don’t withdraw it, you won’t pay income tax. Tax-deferral on annuities lets your interest compound faster. When the guarantee period ends, you can renew for another term or reinvest the entire amount in a new annuity via a 1035 exchange and continue to defer taxes.
On the other hand, CD interest is taxable each year when credited, even if it is not withdrawn.
CDs have penalties for early withdrawal. So do fixed annuities. Withdrawals from annuities larger than allowed by the contract before the surrender period has ended will result in early-surrender charges. However, many fixed-rate annuities let you withdraw up to 10% of the value annually without penalty; some are more restrictive.
With most CDs or annuities, if you choose to receive interest payments instead of reinvesting them, you won’t be penalized.
If you receive interest from your annuity before age 59½, you’ll owe the IRS a 10% penalty on the accumulated interest earnings you’ve withdrawn as well as ordinary income tax. So, don’t buy a fixed annuity if you may need the money before 59½. The IRS will waive the penalty if you’re permanently disabled.
Unlike CDs, fixed annuities are not FDIC-insured, but they are covered by state guaranty associations, which provide some protection up to certain limits. Furthermore, annuity issuers have a good track record, and economists consider annuities to be safe, especially if you choose a highly rated insurer.
Fixed-rate annuities offer terms from two to 10 years. CDs are typically available with terms from one month to five years. A few banks offer terms up to 10 years.
Annuity Rates Dwarf CD Rates
As of early January 2022, you can earn up to 3.15% annually on a five-year fixed annuity. For comparison, the top five-year CD rate was 1.30%, according to Bankrate.
Fixed annuities outperform CDs at shorter terms too, and terms up to 10 years are available. See this annuity rate table.
Why can insurers safely afford to pay more? It’s in large part determined by what insurers and banks can invest in.
Why Insurers Can Pay Higher Rates on Annuities
Banks make their money mostly on loans: mortgages, commercial loans and personal loans, such as auto loans. Interest rates on most loans are low these days. Additionally, banks have to absorb significant overhead costs and loan defaults. They don’t have a lot left over to pass on to CD buyers.
Fixed annuities are backed by the insurance company’s general account. Life insurers invest in a mix of corporate and government bonds, stocks, mortgages, real estate and policy loans. These investments are often longer-term and can offer higher returns than bank loans.
In addition, insurers are primarily regulated by the states. The federal government is the primary bank regulator. These different regulatory systems can give insurers advantages in cost structure, risk tolerance and investment flexibility.
Consider All Options for Guaranteed Rates
If you’re looking to secure a guaranteed interest rate, don’t automatically jump into a bank CD — or a fixed annuity for that matter. CDs and fixed annuities each have their pros and cons, and because of penalties on pre-59½ annuity withdrawals, annuities are usually most appropriate for people in their 50s and older.
But annuities do have two distinct advantages over CDs: tax deferral and typically higher guaranteed interest rates. Today, it’s easy to shop for and compare CDs and fixed annuities online.
A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com/annuity-rates-quotes/multi-year-guarantee-annuities or by calling 800-239-0356.
-
Dow Adds 1,206 Points to Top 50,000: Stock Market TodayThe S&P 500 and Nasdaq also had strong finishes to a volatile week, with beaten-down tech stocks outperforming.
-
Ask the Tax Editor: Federal Income Tax DeductionsAsk the Editor In this week's Ask the Editor Q&A, Joy Taylor answers questions on federal income tax deductions
-
States With No-Fault Car Insurance Laws (and How No-Fault Car Insurance Works)A breakdown of the confusing rules around no-fault car insurance in every state where it exists.
-
For the 2% Club, the Guardrails Approach and the 4% Rule Do Not Work: Here's What Works InsteadFor retirees with a pension, traditional withdrawal rules could be too restrictive. You need a tailored income plan that is much more flexible and realistic.
-
Retiring Next Year? Now Is the Time to Start Designing What Your Retirement Will Look LikeThis is when you should be shifting your focus from growing your portfolio to designing an income and tax strategy that aligns your resources with your purpose.
-
I'm a Financial Planner: This Layered Approach for Your Retirement Money Can Help Lower Your StressTo be confident about retirement, consider building a safety net by dividing assets into distinct layers and establishing a regular review process. Here's how.
-
The 4 Estate Planning Documents Every High-Net-Worth Family Needs (Not Just a Will)The key to successful estate planning for HNW families isn't just drafting these four documents, but ensuring they're current and immediately accessible.
-
Love and Legacy: What Couples Rarely Talk About (But Should)Couples who talk openly about finances, including estate planning, are more likely to head into retirement joyfully. How can you get the conversation going?
-
How to Get the Fair Value for Your Shares When You Are in the Minority Vote on a Sale of Substantially All Corporate AssetsWhen a sale of substantially all corporate assets is approved by majority vote, shareholders on the losing side of the vote should understand their rights.
-
How to Add a Pet Trust to Your Estate Plan: Don't Leave Your Best Friend to ChanceAdding a pet trust to your estate plan can ensure your pets are properly looked after when you're no longer able to care for them. This is how to go about it.
-
Want to Avoid Leaving Chaos in Your Wake? Don't Leave Behind an Outdated Estate PlanAn outdated or incomplete estate plan could cause confusion for those handling your affairs at a difficult time. This guide highlights what to update and when.
