Episode 11: Annuities vs CDs – Which is The Better Option?

Today we’re going to take a deeper looking at two safe money products and compare annuities vs CDs to help you determine which may have the better deal for your situation in retirement.

A CD is a certificate of deposit that is issued by a bank and pays you a guaranteed interest rate for a guaranteed amount of time. CDs are some of the safest and most boring investments you can make because they’re very straightforward and predictable.

As far as I’m concerned, that’s a good thing, especially when you’re retired, because you always want to have some safe money products in your portfolio.

Annuities vs CDs – Which Offers a Better Deal?

Personally, I’m not a huge fan of banks because I think they nickel and dime people to death for services that you can get for free by belonging to a credit union. However, we do need banks and they do serve a very important role in our economy.

That being said, there’s a reason that Mark Twain once famously stated:

“A banker is someone who will loan you his umbrella when the sun is shining, but wants it back the minute it starts to rain.”

Because the bank is going to do what’s good for the bank.

Understanding Multi-Year Guaranteed Annuities (MYGAs)

The first thing you have to do if you’re going to compare annuities vs CDs is to do a true apple-to-apples comparison, and the annuity that most closely resembles a bank CD is the multi-year guaranteed annuity, or MYGA for short.

A MYGA works like a bank CD, meaning it’s a guaranteed amount of interest for a guaranteed amount of time. That’s really where the similarities stop because there are three major differences between MYGAs and CDs:

    • Term Lengths

    • Liquidity

    • Taxes

So, let’s jump into these comparisons and see which may have the best deal for you.

Comparing Term Lengths: CDs vs MYGAS

First, the term length of a CD is going to be relatively short. The banks do not offer guaranteed rates for very long periods.

Most of the time, you’re only going to be able to lock in a rate from about 12 months to 24 months at the longest. And right now, that’s a big deal because rates are high. When someone tells me they can get the same interest rate on a CD that they can get with a MYGA, my response is, “That’s great.  But, what are you going to do in month number 13 when that rate expires with the CD, and interest rates have dropped back down to 2%?”

My point is you’re going to get that guaranteed higher interest rate for 12 months or so, then it’s going to go away and you’re going to have to renew at whatever the current rate would be.  That’s called reinvestment risk.

So in a high interest rate environment, like we’re in at the beginning of 2024, you’re setting yourself up to constantly chase interest rates with the CD versus locking in a rate for a longer period with a MYGA. However, when rates are low you may not want to lock it in for a longer period, so a CD actually could make more sense at that point.

For the last couple of years, I’ve had many clients locking rates for up to 10 years because they know the rates will eventually go back down. And if they can get a really good return that is guaranteed for a decade, they’re going to take it.

Here’s a quick look at term lengths for annuities vs CDs:

Term Length CDs Annuities (MYGAs)
Shortest Term 12 Months 12 Months
Average Term 12-24 Months 5-10 years
Longest Term 5 Years 10 Years

Liquidity Comparison Between Annuities vs CDs

Bank CDs will give you an interest payment only. Meaning if you put a hundred thousand dollars into a bank CD at 5%. You will get $5,000 per year, and you’re not allowed to touch the rest of the money without surrendering the entire CD.

With an annuity, we can set it up to where you would have an option to get up to 10%  of your account value per year if you ever needed it.  Or, you can just take the interest, or you can let it sit there and compound.  You have the flexibility to decide on an annual basis whether you want to take any money or not.

With CDs, as with most bonds, you have to decide at the beginning of the term if you want to take the interest or let it compound. You have to make that choice up front.  There is no flexibility.

Having a 10% withdrawal provision within the annuity can come in handy and it gives you some extra options.

Here’s a quick summarization of annuities vs CDs liquidity comparison:

Feature CDs Annuities (MYGAs)
Access to Funds Access is generally restricted until maturity. Early withdrawal often incurs penalties. Offers more flexibility, such as options to withdraw up to 10% annually without penalties.
Interest Payments Typically paid out annually or upon maturity. Varies; can be set up for periodic interest payments or to let interest compound. Some annuities allow annual withdrawals of interest or a portion of the account value.
Early Withdrawal Incurs penalties, affecting overall return. May allow limited withdrawal (e.g., 10% per year) without penalties, offering more liquidity.
Flexibility in Withdrawals Generally less flexible, with terms set at the outset. More flexible, with options for annual decisions on withdrawals or reinvestment.
Reinvestment of Interest Must decide at the outset whether to reinvest or receive interest payments. More options, such as reinvestment, periodic withdrawals, or accumulation for future use.

Tax Implications for Annuities vs CDs

For tax comparisons, I’m only talking about non-qualified money here. Non-qualified money means you earned it, you already paid the taxes on it, and it’s sitting there waiting to be deployed for living expenses or other investments.

When you put after-tax money into a CD, you are going to get taxed every year on the interest. And that’s whether you take the interest in income, or if you defer it. You are going to get a 1099-I from the bank or institution that issued the CD and you’re going to have to pay tax on that money.

With the annuity, you can actually defer those taxes forever if you want to.

The only time you will pay tax on a non-qualified growth annuity, like a MYGA or a Fixed Indexed Annuity, is when you withdraw the money.

You could technically defer the taxes for the rest of your life if you wanted because there is a provision called a 1035 exchange that will let you continuously roll the money over into different annuities without paying taxes on the gains.

Here’s a summary of tax implications when comparing annuities vs CDs.

Feature CDs Annuities (MYGAs)
Tax on Interest Taxes are due annually on the interest earned, regardless of whether the interest is withdrawn or reinvested. Taxes on the interest can be deferred until the money is withdrawn.
Tax Forms Issuance of a 1099-INT form by the bank or institution, indicating the interest income to be reported. No annual tax reporting on the interest earned unless withdrawals are made.
Tax on Withdrawals Interest income is taxed as regular income in the year it is received. Only taxed when withdrawals are made, and only on the gains, not the principal.
Deferred Taxation No option for deferring taxes on the interest earned each year. Offers the option to defer taxes on interest until withdrawal, potentially advantageous for long-term growth.
Taxation of Principal Principal is not taxed as it is usually after-tax money. Principal is not taxed upon withdrawal, as it is typically after-tax money.
Tax-Advantaged Transfers No options for tax-advantaged transfers or rollovers to other CDs. Allows for 1035 exchanges, enabling the transfer of funds from one annuity to another without immediate tax implications.

Is The CD Better? Or The Annuity?

Going back to the original question, which is better? Annuities or CDs?

If the purpose of the money is protection and risk-free growth, you cannot go wrong with the CD. That’s exactly what they’re built for, and they do the job just fine.

However, when you start to consider term lengths, liquidity, and tax provisions, especially over the long term, MYGAs are typically superior in every way.

In the podcast, I go over several strategies and case studies to help show the differences in each of these products used in the real world. I highly recommend giving it a watch or listening, and if you have any questions about which will work best for your current situation, use the “Schedule a Call” link to get on my calendar.

Podcast Episode: Annuities vs CDs

Also available on Apple Podcast: Episode 11 – Annuities vs CDs

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