Certificates of deposit and fixed annuities are two interest bearing investment options that provide savers with steady returns. Neither CDs nor fixed annuities are subject to fluctuations of principal and consequently, both product types appeal to conservative investors. Despite some broad similarities there are also crucial differences between these investment products.
Fixed annuities are multi-year contracts sold by insurance firms that normally have terms lasting for at least four years. Generally, you buy a fixed annuity with a single premium although some insurance carriers allow you to add additional funds during the contract term. You earn interest throughout the policy term and when the contract matures you can make a lump sum withdrawal or convert your account into a lifetime income stream. Banks and credit unions issue multi-year CDs, but these institutions also offer shorter term CD contracts with terms lasting days or weeks. When a CD reaches maturity you can roll it over and start a new CD contract or cash in the account.
As with certain other types of insurance products, annuity contracts grow on a tax deferred basis. You pay a 10 percent tax penalty if you cash in your tax contract before you reach the age of 59 1/2. Regardless of your age, withdrawals from tax deferred annuity contracts are also subject to income tax. CDs are fully taxable, although you can hold a CD within a tax deferred retirement account in which case your account grows tax deferred. Due to tax considerations, people often invest their long-term savings in annuities while CDs can be used for both short-term and long-term purposes.
The Federal Deposit Insurance Corporation guarantees funds held in bank accounts up to $250,000, per account owner, per bank. FDIC insurance protects both the principal and interest on your CD as long as your account value remains below the insurance threshold. The FDIC does not insure cash held in annuity contracts, although policy premiums are protected at the state level by insurance guaranty funds. Coverage levels vary between states, and guaranty funds protect various other types of life insurance policies in addition to fixed annuities.
Under banking federal regulation D, banks must assess an interest penalty equal to seven days' simple interest when withdrawals are made from CDs within six days of the original deposit date. Generally, banks impose larger interest penalty fees on longer term CDs, but in certain circumstances you can make penalty-free withdrawals from so-called no risk CDs. In many states, insurance firms are required to offer freelook provisions on fixed annuities, which means you can get your premium back if you cancel the contract between 10 and 30 days of the purchase date. Beyond that point, many policies include interest penalties for premature withdrawals, although you can normally make principal withdrawals without paying a penalty fee to the insurer.
- SEC.gov: Annuities
- Florida Life and Health Insurance Guaranty Association: Frequently Asked Questions
- FDIC; Certificates of Deposit; Tips For Savers
- Bankers Online: Early Withdrawal Penalty Requirements For CDs
- FDIC: Deposit Insurance FAQ
- Utah Insurance Department: Buyer's Guide To Fixed Deferred Annuities
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