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.
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.
Sign up for Kiplinger’s Free E-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On the other hand, CD interest is taxable each year when credited, even if it is not withdrawn.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interest from your annuity before age 59½, you’ll owe the IRS a 10% penalty on the accumulated interest earnings you’ve withdrawn as well as ordinary income tax.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.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
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.
-
Come as You Are: Wealth Management for Gen X
Gen X is stuck in the middle of kids and aging parents, but retirement's not far off. Time to prioritize, with help from Nirvana, The Eagles and David Bowie.
By Alvina Lo Published
-
New Job? Time to Start a 401(k) Plan
Whether you're starting a new job or have never opened a 401(k) account, it's time! Here's how to open an account in five steps.
By Adam Shell Published
-
Come as You Are: Wealth Management for Gen X
Gen X is stuck in the middle of kids and aging parents, but retirement's not far off. Time to prioritize, with help from Nirvana, The Eagles and David Bowie.
By Alvina Lo Published
-
UTMA: A Flexible Alternative for Education Expenses and More
This custodial account can be used to pay for anything once the beneficiary is considered an adult in their state. There are some considerations, though.
By Denise McClain, JD, CPA Published
-
How to Create a Retirement Plan That Checks All Your Boxes
You might consider starting with a model retirement plan that has already been assembled and is ready to be refined to meet your objectives.
By Jerry Golden, Investment Adviser Representative Published
-
Why Gen X Marks the Spot for Rethinking Retirement
Retirement plans that worked for Baby Boomers may not fit the bill for Gen Xers. If you're nearing 60, it's time to bring your retirement strategy up to date.
By Chris Blunt Published
-
Want to Turn Your Tax Bill Into a Refund? What to Do Now
A few easy steps can help you avoid writing a check to the IRS. And if your most recent refund was a whopper, you might want to consider a few adjustments.
By Isaac Morris Published
-
FTC Cracks Down: Fake Reviews Officially a No-No
Companies can no longer buy and post online reviews that aren't by actual customers — and there's a hefty fine involved. Here's what to watch for.
By H. Dennis Beaver, Esq. Published
-
Election Could Reshape Opportunity Zones and 1031 Exchanges
Trump and Harris have divergent approaches to qualified opportunity zones and 1031 exchanges. See how each could fare under their administrations.
By Daniel Goodwin Published
-
Six Reasons to Have Life Insurance
The peace of mind from knowing your family is financially protected if something happens to you is invaluable, but there are other compelling reasons, too.
By Anthony Martin Published