CDs Versus Fixed Annuities

Barbara Marquand | guest writer for GoTalkMoney

Fixed annuities are often described as CD-like investments for retirement because they provide guaranteed rates of return. But fixed annuities and CDs differ in a number of ways, and it's important you understand how these vehicles work before you invest.

Certificate of Deposit and Fixed Annuity

Unlike a certificate of deposit, which is issued by a bank, a fixed annuity is issued by an insurance company. You agree to invest a sum in the annuity, and the insurer guarantees you a rate of return. You've probably heard about variable annuities, too. With a variable annuity, your money is invested in accounts similar to mutual funds. The potential for return is greater for a variable annuity than for a fixed annuity, but the risks and fees for variable annuities are higher, too.

Fixed Annuity Investments: Immediate or Deferred

There are two main types of fixed annuities--immediate and deferred. With an immediate annuity, you pay a sum to the insurer once you've retired or are close to retirement, and the insurer begins making regular income payments to you for a certain period of time, such as 10 or 20 years, or until you die. With deferred annuities, your money is invested and accumulates until you are ready to make withdrawals. At that point, you can convert the deferred annuity to an immediate annuity.

Fixed Annuity Advantages

Unlike stocks, fixed annuities provide a steady, predictable income stream to supplement retirement income. Other advantages include:

• Annuities have no IRS investment limits, so they're a good option for people who have maxed out annual contributions to their 401k and IRA accounts.

• You don't need a ton of cash--investment minimums are as low as $1,000.

• Interest earnings are tax-free until you pull the money out.

• Return rates on fixed annuities are often higher than the best CD rates.

Disadvantages of Fixed Annuities:

Annuities are more complicated than CDs, and many people often misunderstand how they work. Disadvantages include:

• There are fees, including a commission for the broker who sells the annuity and a "surrender fee" if you take the money out before a certain date outlined in the contract, usually seven or so years after you purchase an annuity. That doesn't include the 10% penalty you pay on earnings if you withdraw any of the annuity money before you're 59 1/2 years old. Some investment companies do offer "direct-sold" annuities, which have no commission or surrender fees.

• The term "fixed annuity" is a bit of a misnomer. The rate is fixed for a limited period and then can drop, although it can't drop below the guaranteed level.

• Inflation can cut into the purchasing power of your hard-earned money over time if you go for fixed payments for the rest of your life.

• Fixed annuities don't have the earning potential of some other investments, such as stocks.

• You could lose your money if the insurance company that issues the annuity goes bust. With CDs issued by FDIC-insured banks, you get your money back if the bank goes under, as long as your deposits at that institution are within FDIC insurance limits.

Cash Investments: Know Your Options

Financial experts advise against annuities unless you're already investing as much as you can in other retirement plans. Learn the basics of annuities and thoroughly research your options, and remember that brokers who sell annuities make commissions, so they may push the benefits and soft-pedal the drawbacks.

Cameron Huddleston • What to Ask Before Buying an Annuity • Aug 01, 2007 • http://www.kiplinger.comhttp://www.kiplinger.com/basics/archives/2002/04/story25.html
Securities and Exchange Commission • Variable Annuities: What you Should Know • Apr 28, 2009 • http://www.sec.govhttp://www.sec.gov/investor/pubs/varannty.htm

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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