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Differences between Fixed Index Annuities and CDs

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In previous blog posts, we’ve discussed topics such as the growing appeal of fixed index annuities. Changes in the American retirement landscape, such as the shrinking availability of defined-benefit pensions, is prompting many workers and retirees to investigate alternative retirement income vehicles. As a result, total fixed index annuity sales in 2014 shot up 104.3% from total sales figures in 2004, according to Beacon Research ($47 billion in 2014 versus $23 billion in 2004).

But what, then, about CDs? How do fixed index annuities stack up against them? To get a comparative overview of both financial solutions, let’s cover some history as well as key differences.

History of Fixed Index Annuities

Back in 1994, the bond market sustained heavy losses. In fact, it was one of the worst bond market declines in history. A massive bond selloff originated in the United States and Japan, which escalated into further heavy bond dumping in developed economies across the globe. The end result? Bondholders endured losses of over $1 trillion.

Over a 12-month period, interest rates spiked 1.5%. Despite the low risks of the bond market, investors realized nothing was “safe.” Financial instruments such as CDs also offered relatively low return potential. Demand grew for new options which would offer safety from market dowturns and yet more growth potential than financial vehicles with historically low interest rates. As a result, the fixed index annuity was unveiled in 1995. Since then, cumulative sales of fixed index annuities have topped $400 billion.

Fixed Index Annuities vs. CDs

So, in short, the fixed index annuity was created as an alternative to the low yields of CDs. Now here are three quick differences between them:

Principal guarantees – CDs and fixed index annuities differ quite heavily in terms of their principal guarantees. The Federal Depository Insurance Corporation (FDIC) is tasked with insuring bank CDs. In the event of bank failure, it covers principal amounts of up to $250,000. It doesn’t provide any guarantee for earnings.

As previously discussed, as currently set by Congress, banks offer reserves of $0.014 for every dollar. In contrast, state insurance commissions require insurance companies to guarantee one dollar in reserve for every dollar in deposit. As a result, the FDIC offers a “guarantee ratio” of $1.40 for every $100 while insurance companies provide a ratio of $100.00 for $100.00. Also, under state insurance commissions, state guaranty associations provides coverage of up to $250,000 in an annuity contract should the issuing insurance company fail. Note, however, that this coverage amount differs among guaranty associations for different states. For instance, some states have coverage up to $100,000. In many states, insurance carriers are reinsured by other insurance companies so their contracts and policies are covered in the event of company failure.

Tax liability – Unless they’re held in a retirement account like an IRA, CDs are subject to taxation. In contrast, fixed indexed annuities offer tax-deferred income generation and savings growth. For individuals exceeding the maximum allowable contribution limits for IRAs, a fixed index annuity can represent a valuable, tax-advantaged vehicle for growing savings.

It’s important to note that fixed index annuities do come with a heavy early withdrawal penalty, too. Like with other retirement accounts, early withdrawals from an annuity before an investor is aged 59.5 years are subject to a 10% penalty.

Distribution options – CDs come with limited options for fund distributions. In many cases, you’ll have a short window in which to withdraw money or add new funds to your account – usually during a period of CD maturation. Otherwise the CD automatically renews for a new, certain period – early withdrawals may be subject to penalties, too.

Comparatively fixed index annuities offer a number of choices. In general, annuity holders may be able to receive their money in amounts they specify after a specific period of time has passed. Withdrawal limits will vary from contract to contract, and it’s also important to note the length of annuity ownership required before surrender charges disappear. Annuities also offer another benefit.

Generally you have the ability to annuitize the contract at any point, which lets you receive a guaranteed lifetime income or ongoing payments for a certain set period. With joint and survivor options, fixed index annuities enable you or your partner to receive payments as long as one of you is alive, as well.

Other Important Details

It’s also worth noting that fixed index annuities and CDs can differ in terms of early withdrawal penalties and provisions of renewal. They can differ depending on the particular products you’re comparing.

Also worth noting is the the ability of a fixed index annuity to earn interest. Its growth potential is limited in exchange for the security it offers from market volatility. Interest earnings can vary depending on how the index to which the annuity is linked performs, and how the annuity calculates interest earnings potential, among other factors. To reemphasize, fixed index annuities were created as an alternative to CDs and other conservative vehicles. They're designed to offer strong financial growth opportunities than CDs do.

Interested in Learning More?

The bottom line? Fixed index annuities were created as an alternative to CDs. But like with all financial solutions, their value will differ among investors. It’s important to determine your goals and evaluate whether this retirement vehicle is a suitable fit for your needs.

If you're ready for personal help, SafeMoney can assist you. Use our Find a Licensed Advisor section to connect directly with an independent financial professional, and to request a personal strategy session to discuss your needs and goals. And should you have any questions or concerns, call 877.476.9723.

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