Published on March 22, 2009
Annuities vs. CDs White paper Asset Marketing Systems Insurance Services, LLC 9715 Businesspark Ave. | San Diego, CA 92131 | www.assetmarketingsystems.net (888) 303-8755
If a prospect is questioning whether the best place for his or her money is a certificate of deposit (CD) or a traditional deferred fixed annuity, the answer depends upon the prospect’s individual financial situation and investment objectives. Both CDs and traditional fixed annuities are savings vehicles used to accumulate wealth. Let’s compare them. Safety of Principal Both CDs and traditional fixed annuities are low–risk savings vehicles. CDs are generally issued by banks and, in most cases, are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor. Should the bank fail, the FDIC guarantees CDs up to this amount. CDs typically pay a stated interest rate for their term. A traditional fixed annuity is a contract between an individual and an insurance company to pay a stated interest rate for the term of the contract. Traditional fixed annuities are not insured by the U.S. government. They are backed by the financial strength of the issuing insurance company, regardless of the amount. You can determine an insurance carrier’s financial strength by requesting the findings of independent rating companies such as Moody's, A.M. Best, Standard & Poor's and Fitch. These companies evaluate the financial strength of insurance companies and publish ratings that give their assessments of each company. The law also requires insurance companies to set aside reserves for the money they guarantee, which makes them typically less financially vulnerable than banks, which can loan out the money they receive from depositors. Additionally, most states have what is known as a state guaranty association. The purpose of the association is to provide additional “safety net” coverage to all residents of the state who purchase certain insurance products. However, it is often unethical to use the existence of the guaranty association for marketing purposes. You can learn more about your state guaranty association and the laws governing it here. Short–term Accumulation When deciding between a CD and a traditional fixed annuity, one’s investment horizon should be a key consideration (the investment horizon is the amount of time needed to save for a specific goal). For short–term goals (e.g., the purchase of a new car), a short-term CD may prove to be a better choice as CD maturity periods are typically shorter than those for traditional fixed annuities. These can be as short as one month. Medium and Long–term Accumulation A traditional fixed annuity is generally the product of choice for the longer haul (e.g., retirement savings, retirement income planning or intergenerational planning). Traditional fixed annuities generally have longer-term maturities beginning at two years and ranging to about ten years. They are designed to help accumulate money for retirement or to protect funds already saved in retirement. In later years, a traditional fixed annuity is usually more flexible for accessing money. They can even be used to provide a legacy. Interest Return CDs offer a guaranteed rate of return for a specified period of time. Interest rates Annuities vs. CDs Page 2
will vary depending on current market conditions and the length of time to maturity and may generally be reviewed here. Typically, the shorter the period of time to maturity, the lower the rate. There is no guaranteed minimum for renewal rates. With a traditional fixed annuity, a guaranteed interest rate is locked in for a stated period. Sometimes the rate is locked in for the life of the contract. Other times the rate is only locked in for a stated initial period; after that, the interest rate may be adjusted periodically, generally each year with a guaranteed minimum interest rate, regardless of market conditions. Information concerning what traditional fixed annuities are available, their terms and the rates paid on them is available by contacting Asset Marketing Systems at 888.303.8755. Tax Savings If taxes are a concern, a traditional fixed annuity may be a better option for several reasons. Earnings on CDs are taxable in the year the interest is earned, even if the money isn’t taken out. With traditional fixed annuities, earnings accumulate tax– deferred and are not treated as taxable income until they are withdrawn, which provides a measure of control over when taxes are paid. Thus the premium earns interest, the interest earns interest, and the money saved by deferring tax payments earns interest. As the chart below illustrates, it makes good investment sense, when saving for the longer term, to have the power of tax deferral. Annuities vs. CDs Page 3
This chart does not take into account taxes payable upon withdrawal from the annuity. However, even after paying taxes on a lump sum withdrawal in the above example, the owner will still come out ahead, assuming no increase in the tax rate. Traditional fixed annuities may also help reduce or eliminate taxes on Social Security benefits. By leaving money in a traditional fixed annuity, one can reduce taxable income, keeping it below the level where one would begin to owe taxes on Social Security benefits. With CDs, interest earnings count in the calculation of how Social Security benefits are taxed — even if earnings aren’t withdrawn. As much as 85% of your Social Security benefits could end up subject to taxation. At death, the annuity's account value will be paid directly to the named beneficiary or beneficiaries, avoiding the costs and delays associated with probate. This is not the case with a CD, which may be subject to probate. Note, however, that both traditional fixed annuities and CDs are subject to estate tax, and the earnings inside a traditional fixed annuity are subject to income tax when paid out. The earnings in a CD were taxed when earned. Liquidity If a CD’s owner needs access to the funds in a CD prior to the maturity date, an interest penalty ranging from 30 days' to six months' interest is typically owed. Of course, one can limit exposure to surrender penalties by investing in several CDs with staggered maturity dates. A traditional fixed annuity also provides access to one’s money should the need arise. Withdrawals during the first several years are generally subject to surrender charges. Most companies provide the flexibility, however, to withdraw a portion of the annuity's account value, usually 10% each year, without a company–imposed surrender charge. Once the surrender charge period has expired, one can generally access the money at any time without surrender penalties. Withdrawals may be taxable and, if they are made prior to age 59½, may be subject to a 10% penalty. Distribution Options at Maturity When a CD reaches maturity, one can take the CD's lump sum value in cash, renew the CD for the same or different maturity period or examine other alternatives (such as a traditional fixed annuity). With a traditional fixed annuity, one may elect to withdraw the money in a lump sum or select a lifetime income option, which provides you with a flow of income that one cannot outlive. One could also elect to let the funds continue to accumulate until a need arises. Availability Both CDs and traditional fixed annuities are widely available. CDs are generally available from banks and similar financial institutions. Insurance agents, stockbrokers and financial institutions all sell annuities. Annuities vs. CDs Page 4
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