The Fixed Annuity- Is it Really just a Glorified Certificate of Deposit (CD)?

In the world of investing, there are many types of solutions. If you have ever watched a PGA golf tournament on a Sunday afternoon, you have seen the flood of commercials from financial institutions — Fidelity, Schwab, and even Pacific Life, whose ads end with their signature whale breaching the water. Each firm advertises something different, from comprehensive financial planning to stock trading to the often-misunderstood annuity. With so many choices, matching the right solution to your specific need can be difficult. It’s always smart to do your research before choosing an investment. Easier said than done. To keep things focused, let’s zoom in on just one solution: the fixed annuity. As you’ll see, a fixed annuity is really just a glorified CD. So what is a CD?

When someone walks into a bank and asks about CD rates, they are asking for safety and a guaranteed rate of return. The issuing bank guarantees both. The deal is simple: give the bank a lump sum for a fixed number of years, and at the end you get your principal back along with annual interest. A 3-year CD might pay 1.25% a year; some run as high as 2.2% depending on the institution. If you need the money early, the bank can penalize you, so only commit funds you won’t need during the term.

So what is a fixed annuity, and why is it a glorified CD? A fixed annuity works almost exactly like a CD. You hand a lump sum to an insurance company — not a bank — and you’re guaranteed a rate of return. Common terms are 3, 5, 7, and less often 10 years. Longer terms usually come with higher rates. At the time of this writing, fixed annuities are paying roughly 2.75% to 3.90%, depending on the insurer and the premium. But there are meaningful differences between a CD and an annuity, and those differences can create advantages.

The main difference is that annuities are not FDIC insured; they are backed by the claims-paying ability of the insurance company. The second big difference is tax-deferred growth. CD interest is taxed every year, but annuity interest is not taxed until you withdraw it. Deferring taxes lets your money compound more efficiently. So why buy a fixed annuity? It’s a fit for someone looking for a better rate than the bank, combined with tax-deferred growth. Fixed annuities are not a growth strategy — they are a wealth-preservation tool with a slightly better yield. They should be a small piece of your overall plan. Always take time to understand the annuity contract and check for hidden fees. With plain fixed annuities there usually are no fees, unless you add a rider (which we’ll cover in a future article). As always, thanks for reading. If you have any questions, feel free to reach out to anyone at CFEFinances.com. Happy investing!