Fixed-Rate Annuity or Certificate of Deposit?

Annuities are commonly used to establish a steady stream of income in retirement. Panchenko Vladimir/Shutterstock

Stocks seem overpriced today, you think. So, you want to move some of your investments into safer places. Safer in the sense that your principal amount is protected, even if it means you only earn 4 or 5 percent. Peace of mind—that your money is safe and secure—is worth a lot!

You can consider money market funds, certificates of deposit, or annuities. You can even look at short-term U.S. Treasury bills. While all these are paying only single-digit interest or returns on your investment, lately we are seeing slightly higher fixed rates on certain annuities than certificates of deposit.

What Are Annuities?

An annuity is a contract between a buyer and an insurance company. It provides the buyer with a regular series of payments in return for a lump-sum payment. Annuities are commonly used to establish a steady stream of income in retirement.

Insurers offer fixed-rate deferred annuities that resemble certificates of deposit (CDs), but lately offer higher yields generated from the broad portfolio of investments insurance companies maintain (such as government and corporate bonds, stocks, and real estate).

These products allow the buyer to defer taxes on earnings. They are available through brokerages, banks, and annuity agents. Fixed-rate annuities offer guaranteed payouts at a fixed interest rate and provide stable, predictable income. Fixed-rate deferred annuities have been the top-selling category of annuities in 2024, totaling $124 billion in the first nine months, up 17 percent from the same period in 2023.

Other Types of Annuities

• Immediate: Payouts start almost immediately after a lump-sum investment.
• Deferred: Begin at a future date, allowing the investment to grow tax-deferred.
• Variable: Vary based on the performance of investment options chosen within the annuity. These offer the potential for higher returns but also come with higher risk.
• Indexed: Linked to a stock market index. These provide the potential for higher returns with some downside protection (kind of a balance between fixed and variable annuities).

Benefits of Annuities

• Can provide income for life, reducing the risk of outliving your savings.
• Earnings grow tax-deferred until withdrawal.
• Can be tailored to meet individual needs with various options and riders.

Drawbacks of Annuities

• Can be complex and come with high fees and expenses.
• Early withdrawal may incur significant penalties.
• Fixed payouts may not keep up with inflation.

The Federal Reserve’s rate increases that began in 2022 lifted the rates on these long-overlooked products, increasing the demand for annuities.

These annuities are especially appealing to baby boomers because they desire conservative investments. These products differ from traditional retirement-income annuities that turn a lump sum investment into a monthly payout for life.

With annuity features such as rolling the money over tax-free into different fixed-rate deferred annuities, the investor can withdraw principal and interest and pay income taxes only on the gains, or he or she can purchase a pension-like annuity providing income for life.

Annuities Can Be Risky

The investor must determine whether the insurer standing behind the annuity is in good financial health. Annuities aren’t backed by the Federal Deposit Insurance Corp., as are most CDs. To rate these insurance companies, check S&P Global, Moody’s, and A.M. Best.

If an insurer should become insolvent, however, the annuities are protected by a state-based (coverage varies by state), industry-funded system of guaranteed associations. So it is important to keep your contract amount below the state-guaranteed limit.

Are Fixed-Rate Annuities for You?

Fixed-rate deferred annuities are for people who can leave their money alone until the contract matures, much as a CD. If you cannot wait until maturity, you may suffer a surrender charge that can be as high as 7 percent.

This is no different than a CD in this regard. (Bank CDs have early withdrawal penalties, 90 days of interest on maturities less than one year and 180 days for terms of one year and longer, according to Bankrate.com.) The contract may specify an “adjustment” of the principle to the current market value upon withdrawal, and a resultant loss occurs.

Variable annuities are tied to specific investments (e.g., indexes, mutual funds). The returns depend on the investment performance, so you don’t have the predictability that you have with fixed-rate annuities. We are focused on fixed annuities in this article because you now can earn interest rates higher than CDs in many cases.

Tax Considerations

Being able to defer taxes on the annuity interest is advantageous to those in higher tax brackets, especially if they expect to be in a lower tax bracket when the annuity matures. High income-tax states will likewise provide investor incentives to invest in U.S. Treasury bonds given interest income is exempt from both state and local taxes.

Annuities offer tax-deferred growth, meaning you won’t pay taxes on the interest, dividends, or capital gains if the money remains inside the annuity.

In the case of “qualified” (retirement plans funded with pre-tax dollars) annuity withdrawals before age 59½ may incur a 10 percent federal penalty tax on top of ordinary income taxes. Also, some states such as California impose a 2.5 percent early withdrawal penalty. In the case of funded annuities using after-tax dollars, only the interest portion of withdrawals is taxable as ordinary income.

Summary

Before purchasing an annuity, it’s important to consider all the variables and factors to ensure they align with your financial goals and needs:

• Fees and expenses: The contract may include management fees, surrender charges (penalties), and optional “rider fees” such as for including death benefits or income guarantees.
• Ensure the fixed interest rates meet your income needs.
• Financial strength of the insurer: check financial strength and stability from the ratings agencies (listed above). Consider the insurer’s reputation and history in the industry.
• Tax implications: Understand that earnings grow tax-deferred until withdrawal. Determine if the annuity is part of a qualified retirement plan or purchased with after-tax dollars (qualified versus non-qualified).
• Liquidity: Check for provisions that allow you to withdraw money in emergencies without heavy penalties. Be aware of any limits on annual withdrawals without incurring fees.

For those of you who are seeking conservative, predictable interest earnings, you can now go beyond considering only the money market, U.S. Treasurys, and certificates of deposit, as fixed-rate annuities today are offering highly competitive rates.

The Epoch Times copyright © 2025. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.