The Fixed Annuity- Is it Really just a Glorified Certificate of Deposit (CD)?
In the world of investing, there are many types of investment solutions. Have you ever watched a PGA golf tournament on Sunday afternoon and noticed how many commercials there are for financial institutions…Fidelity, Schwab, even Pacific Life, which ends its commercial with their logo…a whale jumping out of the water. Each company advertises a financial concept ranging from overall financial planning to stock trading, or even the misunderstood annuity. With so many investment solutions it can be difficult to match a solution with a need.
It’s always prudent for one to do their research before choosing an investment. Easier said than done. So to help navigate, let’s just focus on one financial solution, which is the fixed annuity. The fixed annuity as you will see is really just a glorified CD.
So what is a CD?
When a person enters a bank and asks for CD rates, they are asking for safety and a guaranteed rate of return. The bank who issues the CD guarantees both to the customer. The banks says, give us a dollar amount for a certain number of years and we will give you your money back at the end of those years along with interest each year. So you can buy a 3 year CD that pays 1.25% a year, maybe even as high as 2.2% depending on the bank. If you need money from the CD, the bank can penalize you, so if you buy a CD make sure you don’t need the money within that time period.
So then what is a fixed annuity and why is it a glorified CD?
The fixed annuity functions exactly the same way as a CD. Provide a lump sum of money to an insurance company, not a bank, and you are guaranteed a rate of return. A fixed annuity can tie your money up for 3, 5, 7, and the not so common 10 years. The longer the time frame the higher rate of return. Some fixed annuities at this time of publication provide anywhere from 2.75%-3.90% depending the on insurance company and the initial premium. However, there are differences between a CD and an annuity, and those differences can lead to some advantages.
The main difference between fixed annuities and CD’, are that annuities are not FDIC insured. They are insured through the insurance company. The other main difference is annuities allow for tax deferred growth, unlike CD’s, which interest is taxed each year. Tax deferred growth means that the interest you earn is not taxed until you withdraw the money. By deferring taxes your money can grown more efficiently.
So why buy a fixed annuity? A fixed annuity is for someone who is looking to get a better rate of return than banks can offer, but also have the benefit of tax deferred growth. Fixed annuities aren’t growth oriented strategies, they are ways of preserving wealth and getting more interest. They should be a small part of your overall investment strategy. Always take the time to understand the annuity contract and look for any hidden fees. With fixed annuities there usually isn’t any fees unless you buy a rider, which will not be discussed in the article.
As always, thanks for reading and if you have any questions, feel free to reach out to anyone at CFE Finances.com.