Fixed annuity vs. CD: A side-by-side comparison

If you're looking for a conservative way to earn a fixed rate of return on your money, certificates of deposit (CDs) and fixed annuities are both viable options.

Looking at a fixed annuity vs. CD side by side can help you figure out which option is best for your investment plan. Both options also may work within your plan.

Fixed annuities and CDs are both choices that offer:

• A guaranteed rate of interest for a set period of time
• No exposure to stock market risks

There are notable differences in the way fixed annuities and CDs work including the timing of taxation, liquidity, the interest rate period, and your options at the end of the term. Here's a closer look at the differences.

The interest you earn on both fixed annuities and CDs is taxed as income. However, there are differences in the timing of the taxes you’ll owe.

• Fixed annuities are generally tax-deferred. This means any earnings inside the contract are not reported as income each year. Eventually, you will pay taxes on those earnings when you withdraw money. This gives you some control over when annuity income hits your tax return.

• CD interest is taxed each year. Annual interest is calculated each year and reported to you on a Form 1099-INT. If you hold a fixed annuity or a CD inside a tax-deferred account like an individual retirement account (IRA), these features might not matter as much because the IRA itself is tax-deferred. In that case, you typically only pay taxes when you take distributions from the IRA.

Liquidity is how easily an asset can be converted into cash and be spent. Withdrawing before the term ends from both fixed annuities and CDs can result in different types of penalties:

• Fixed annuities  often have a surrender charge period. If you withdraw money during the surrender charge period outlined in the contract (typically three-10 years), you may be charged a fee or penalty. Surrender charges are typically a percentage of the amount withdrawn. However, some fixed annuity contracts allow you to withdraw a certain amount of your balance each year, such as up to 10%, before surrender charges apply.

• CDs often have an interest penalty. Particularly if you choose a short CD period, like six months, or if you create a CD ladder—where you have several CDs coming due on a rotating basis—you can easily time access to your money. However, withdrawing funds early from a CD usually means you'll pay an interest penalty of several months' worth of interest earnings.
  

The interest rate period for fixed annuities is typically longer than the term for a CD.

• Fixed annuity interest rates are often set for an initial period but may fluctuate after. While the rate on a fixed annuity will fluctuate after the guaranteed period, the rate never will fall below the guaranteed minimum interest rate in the contract. This could be beneficial during low-interest rate environments. Additionally, a specific type of fixed annuity called a multi-year guaranteed annuity (MYGA) can provide a fixed interest rate for a specified holding period.

• The CD interest rate is fixed for the term. The rates you can get depend largely on the interest-rate environment at the time of purchase. At the end of the term, you can renew the CD, but it will be at the updated interest rates.
  

Compared to certificates of deposit, fixed annuities provide more options for withdrawing your money, especially in retirement.

• Fixed annuities have several withdrawal choices. You may receive your fixed annuity in a lump sum, but you can also choose to annuitize and receive regular payments for a specified number of years or receive a guaranteed payment for life.

• The balance of a CD is returned to you in a lump sum. When your CD reaches its maturity date, you can choose to withdraw your principal and accumulated interest or renew part or all of the CD for the same or a different term and a new interest rate.

Types of fixed deferred annuities: Is one right for you?

Different types of fixed deferred annuities—such as a fixed rate, fixed index and multi-year guarantee—are better suited to some people than others. To help get the most out of a fixed annuity, it's important to understand the structure of each and how it will fit with your long-term financial plans.

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Fixed annuities may be more appropriate for people who may not need to access their money in the near future and are looking for tax deferral.

• Tax-deferred earnings
• Potential for lifetime income options
• Long-term time horizon

• Subject to surrender charges on early withdrawals—not appropriate for short-term goals
• Guarantees are based on the financial strength and claims paying ability of the issuing insurer

CDs are better for reaching short-term goals because they often have shorter maturity periods, but they do not provide tax-deferral or lifetime income options.

• Higher liquidity, interest penalty for early withdrawal but no surrender charges
• Support for short-term financial goals
• FDIC or NCUA insurance protection
  

• No option to annuitize and create an income stream
• Does not provide tax-deferral
  

In addition to looking at the differences between fixed annuities and CDs, consider your goals. At times, one of these investment options may be better than the other.

If you have a short timeline to reach your goal, such as saving up for a down payment on a house or buying a new car, then a CD may be a better option.

As a tool for creating income in retirement, a fixed annuity is generally more beneficial. If you don't plan on accessing your money before the surrender charge period is over, then early withdrawal penalties likely won't matter. Plus, it provides you with a range of annuity payments to support your retirement goals.

Fixed annuities and CDs both provide a guaranteed interest rate while protecting your principle from market fluctuations. However, fixed annuities provide you with tax deferral and withdrawal options that CDs don't, while CDs offer more liquidity. But also consider that you don't need to choose just one. You might want to use CDs for short-term goals alongside a fixed annuity for tax deferral and the lifetime income option.

Choosing the right one will look different for everyone. Weighing the pros and cons of each can help you create a strategy based on your unique goals. For guidance on what savings and investment tools are a good fit for your financial goals, consider meeting with a Thrivent financial advisor and discussing all your options.