Annuities vs. Certificates of Deposit (CDs)

There are many savings options for retirees, ranging from 401(k)s to IRAs, and even HSAs. However, there are some other lesser-known savings vehicles that may be worth considering, as well. While both a fixed annuity and certificate of deposit (CD) can provide retirees with regular payments, they differ in several ways and each has its own disadvantages. A financial advisor can help you determine whether an annuity vs. CD makes the most sense based on your retirement plan.

What Is an Annuity?

An annuity is an agreement between an annuity owner and an insurance company.

You contribute a set amount in exchange for steady payments at a set date in the future. During the accumulation phase, the annuity owner will fund the account, and then during the annuitization phase, they begin receiving regular payments.

Annuities can make payments for a set amount of time or for the lifetime of the annuity owner. There are different types of annuities, including fixed, variable and indexed annuities.

Retirees commonly use annuities for retirement income due to their guaranteed income stream. Other retirement savings options, in comparison, don’t automatically make regular payments, making you reliant on other income sources.

What Is a Certificate of Deposit (CD)?

A certificate of deposit (CD) is an agreement between you and your financial institution. You deposit a set amount of cash for a predetermined amount of time, and your bank or credit union provides a guaranteed return in exchange for your loyalty.

The CD’s interest rate determines the kind of return you receive. Many consider CDs among the most safe investments on the market because they feature a guaranteed interest rate and carry FDIC insurance, up to $250,000.

Upon maturity of a CD, you receive a lump-sum payment that includes both your principal (the original investment amount), plus interest earned. From there, you can move the funds into a new CD, or you can cash out the fund, with the latter providing a lump sum payout via check.

A CD ladder is one way to stagger your maturity dates by dividing your funds between multiple CDs. In doing so, you stagger your payouts for steady income.

However, CD rates can vary significantly, depending on the financial institution offering them. Because these rates affect your overall earnings, it’s important to do your research so you can secure the best CD rate possible.

Annuities and CDs Compared

You can use both annuities and CDs as financial tools while saving for medium- and long-term financial goals. However, there are some important distinctions between the two.

Both CDs and annuities offer a guaranteed return once they hit maturity or enter the annuitization phase. However, they pay out through different means. For example, annuity owners receive regular payments once they enter the annuitization phase. Meanwhile, CD owners receive payment once their CD matures.

You also have the option to invest in a CD ladder instead of a single CD. In this case, the different maturity dates of each CD can offer semi-regular payments from your CDs. By offering payments instead of a lump sum, a CD ladder is similar to an annuity.

Annuity vs. CD: Which Is Right for You?

Generally speaking, CDs can help save for intermediate goals with little risk, such as a down payment for a house. Meanwhile, annuities can offer an additional income stream in retirement.

Because CDs offer a lump-sum payment upon maturity, you can put money away relatively risk-free and then access it at a predetermined date. CD ladders work differently due to their staggered maturity dates, allowing you to receive multiple lump sum payouts over time.

Annuities, on the other hand, dole out regular payments once they hit the annuitization phase. These payments may continue for either a predetermined period or for the annuitant’s lifetime.

It is also important to note that the IRS taxes annuities and CDs differently. While the IRS does not tax a CD’s principal balance, it does tax interest. The taxation of annuities, on the other hand, depends on their structure and funding. Annuities funded with pre-tax dollars are taxed upon withdrawal of funds. However, if you used after-tax dollars to fund your annuity, a part of your payout will be a tax-free return of the principal.

In either case, annuity taxes are calculated at your income tax rate, not the lower capital gains tax rate.

Liquidity and Access to Funds

When comparing annuities vs. certificates of deposit, one of the most important distinctions lies in accessibility and liquidity, or how quickly an investment can convert into cash without significant losses

Certificates of Deposit

Certificates of deposit generally offer more liquidity than annuities, though not without cost. When you open a CD account, you agree to keep your money deposited for a specific term, such as six months, one year or five years. If you withdraw funds before the CD matures, the bank typically charges an early withdrawal penalty, which can range from a few months of interest to the total interest earned during the term. Despite these penalties, CDs remain relatively easy to access since the funds are held at a bank and insured by the FDIC.

Annuities

Annuities, on the other hand, are structured as long-term contracts designed to provide income in retirement. They usually include a surrender period, which is a set number of years during which the insurance company charges a fee for early withdrawals. These surrender charges typically decline over time but can initially range from 5% to 10% of the amount withdrawn.

In addition to these charges, annuity owners under age 59½ may face a 10% penalty from the IRS on earnings withdrawn early. This is in addition to any ordinary income taxes owed the taxable portion. This makes annuities far less liquid than CDs, particularly in the first several years of ownership.

Annuity vs. CD: A Combined Approach

Both products can play complementary roles depending on your financial goals. CDs are often better suited for short- to medium-term savings goals where access to funds might be necessary. Annuities, by contrast, are best used as long-term income vehicles for retirement, where the focus is on generating dependable payments rather than maintaining liquidity.

Some retirees even use a combination of both, holding CDs or money market accounts for emergency reserves while committing other funds to annuities that deliver predictable income.

The trade-off between liquidity and income is one of the central considerations when choosing between CDs and annuities. CDs give savers confidence that their funds can be accessed with modest penalties if needed. Meanwhile, annuities reward long-term commitment with higher yields and guaranteed payments later in life.

Evaluating your cash flow needs, risk tolerance and time horizon can help determine how much flexibility and income security you need for your retirement.

Bottom Line

A couple filling out forms at their bank.

Both annuities and CDs are savings vehicles offering a guaranteed return, but the best option for you depends on your financial goals. If you want to set aside money for medium-term financial goals with little market risk, a CD may be your best bet. However, if you want to add an additional income stream in retirement to avoid outliving your assets, an annuity is a better option.

A financial advisor can help you evaluate your options so you can find the best option for your retirement.

Savings Tips

A financial advisor could help you figure out how CDs and annuities fit into your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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