When looking to invest, individuals must contend with numerous financing options and an overwhelming array of choices. It is important to objectively sort through these financial products, researching them, and learning more about them to develop financial literacy. One key choice successful investors make is to distinguish amongst products and to ponder questions such as, ‘Who is promoting this? Why are they introducing this product? Does it fit my personal needs or goals?’ In this article, The Annuities Consultants will delve into the differences between Certificates of Deposit (CDs) and annuities and break down the options without the motive of a bank to push their own fiscal interests. Therefore, we aim to introduce an unbiased perspective of CDs versus annuities.
If one walks into a local big bank or neighborly credit union, they might notice the advertising campaigns proudly displaying the bank’s promotional products in their branding colors. A person might see placards displaying the latest low APR rates on luxe credit cards, or the going rate for CDs. CDs feature a variety of benefits and are indeed a viable method of saving money. CDs are most often used by commercial banks, or the larger corporations, that can afford to take the profits they earn from loans and reward other customers with interest on their deposits. A CD functions similarly to a loan in that a client has to sign a promissory note that binds them into a contract with the bank. The difference is that the agreement entails that the consumer is aware that they will be making deposits into the CD at a fixed rate of interest for a certain period of time, as opposed to borrowing money and acknowledging the responsibility to pay it back. In the promissory note, the client also concurs that they are not allowed to withdrawal amounts ahead of schedule.
The CD is designed so that a client will invest their money, acquire more interest than a typical savings account, and the monies are backed by the FDIC (Federal Deposit Insurance Corporation) for security. A client is penalized for withdrawing from their CD, or not allowed to withdraw funds at all, depending upon the type of product selected. Now, to a typical client with money to invest, a CD appears to be an outstanding product, especially when one learns how little interest they earn from a savings account. According to Go Banking Rates findings here, the average national savings account’s interest rate is 0.06%. If a customer puts in $100 in an average account with the interest compounded 12 times per year, then the bank rewards them with only approximately $6.08 after 10 years. As a person journeys through life, imagine their career takes off and an employer offers them a 401K. They recognize how little their interest rate is earning them at the bank and gladly invest in a 401K product with a higher interest rate.
Now, it is obvious to understand that the bank seeks to promote its own products; the CD is designed to reward consumers with higher interest rates, averaging say 2%. If the consumer invests $100 into their CD with interest compounded annually and doesn’t touch the money for 10 years (CDs require a longer period of time before one can withdrawal the money), they earn about $21.90. The CD generates about $15.82 more for every hundred dollars and gives the bank some competition against 401Ks. However, what if there is a product with an even higher interest rate out there that a person never hears of because their bank does not offer that option? That’s precisely where an annuity comes into play.
An annuity has a higher interest rate than a bank’s CD, often offering a 3% interest rate at the lowest. Please keep in mind that if a client elects an indexed annuity, they potentially earn 3-8%, according to conservative estimates. However, working with a 3% interest rate still produces more earnings than a CD. If one invested that same $100 compounded 12 times annually at 3%, one earns a staggering $34.94. An annuity is a plan that is also illiquid, or one cannot withdraw the funds early without paying a surrender fee. However, annuities are flexible and have a variety of payment options. Unlike a CD offering a lump sum payment, an annuity is most commonly used for retirees and pays out a fixed payment over a fixed period of time. For example, a person elects to have themselves, or their spouse, receive a payout of $500 monthly when the annuity matures, for a period of ten years. An investor can also add the option of a death benefit to an annuity, allowing them to also have a lump sum payment upon their death for family or relatives. In conclusion, the higher interest return, flexibility, and death benefit options make annuities a superior product.