CDs or Fixed Annuities: Which is a better way to save for retirement?

No one wants to run out of money in retirement. You’ll need to plan ahead if you’re hoping to have enough savings to live off into your 70s, 80s and even 90s. It’s also important to carefully consider where to store the funds you’ll eventually use for income in retirement. Sometimes figuring this out can be more difficult than saving the money itself.

When planning for retirement, you may find yourself choosing between certificates of deposit (CDs) and fixed annuities. Both of these can be low-risk options, which appeal to conservative investors, but there are also some significant differences to consider.

What is a CD?

Often available from banks and credit unions, a CD is an account that usually pays a guaranteed rate of return for a set period of time. You’ll select the term length when you open the CD, and terms often range from a few months to several years.

In exchange for the benefit of a fixed rate with a CD, you’re agreeing to lock up the funds for the entire term. Taking out the money ahead of time typically results in an early withdrawal penalty, which could cancel out the earned interest and possibly some of the principal.

What is a fixed annuity?

A fixed annuity is a contract, usually with an insurance company, that guarantees a certain amount of income in exchange for your providing money up front. Some annuities are set up to pay you an income for the rest of your life, while others only provide payments for a set amount of time.

A fixed annuity can allow you to build wealth in a tax-deferred account. Depending on how an annuity is structured, it may also provide a death benefit that functions like life insurance.

Like CDs, annuities could come with penalties for needing access to your money early. If you take money out of an annuity before you reach age 59 1/2, you could be charged early withdrawal penalties, be hit with taxes on your gains, and lose tax-deferral benefits.

Fixed annuities vs. CDs: Rates

CD rates are often impacted by interest rate decisions made by the Federal Reserve. The Fed raised rates 11 times in 2022 and 2023, resulting in elevated returns on many high-yielding CDs.

Historically, annuity rates have been higher than CD rates found at the bank, says Bryan Bibbo, an advisor at the JL Smith Group in Avon, Ohio. Still, it’s worth your time to compare top rates on CDs and fixed annuities from various financial institutions before deciding which option is better for you.

Both CDs and fixed annuities often promise a guaranteed rate of return.

Fixed annuities vs. CDs: Terms

When choosing between a CD and a fixed annuity for retirement, consider how soon you’ll want access to your funds. Both CDs and fixed annuities commonly impose penalties for early withdrawals.

CDs usually require that you leave your money untouched for a set term, after which you can withdraw the principal and interest. Fixed annuities allow you to take payments immediately, or you can take payments at a later date, as part of a deferred annuity structure.

Fixed annuities vs. CDs: Security

CDs and fixed annuities are similar because in the end, you’re guaranteed to receive your principal investment plus a certain amount of interest. But they’re insured by different entities.

When a CD is offered by a bank that’s insured by the Federal Deposit Insurance Corp. (FDIC), your funds are protected in case of a bank failure. Likewise, credit unions have their own form of deposit insurance that’s administered by the National Credit Union Association (NCUA). These forms of deposit insurance protect up to $250,000 per depositor, per insured institution, per ownership category.

On the other hand, fixed annuities are insured by insurance companies, which aren’t always financially secure or creditworthy. If an insurer goes bankrupt, however, another will likely step in. Annuity holders will get some sort of minimum guaranteed payout, but their interest rate will be reduced, according to Bibbo.

Bibbo recommends reviewing insurers using data from two or three credit agencies and finding out how financially sound a particular company is before funding an annuity.

Craig Kirsner, president and investment adviser at Kirsner Wealth Management (previously a retirement planner and an investment adviser representative at Stuart Estate Planning Wealth Advisors when this article was first published), says that few insurance companies ever fail.

Fixed annuities vs. CDs: Taxation

The guaranteed rate of return is nice for savers with CDs, but they pay the price when tax time rolls around.

If you have a CD, expect to pay taxes on any interest you earn every year, even if you don’t have access to that money. With annuities, however, pre-tax money you’ve contributed grows on a tax-deferred basis, and you won’t owe any taxes until you’re ready to make a withdrawal. If you contribute with money that’s already been taxed, any contributions to the account will come out without being taxed.

“If you’re in a higher tax bracket and don’t need the money for some time, you’ll enjoy the power of tax-deferred compounding inside an annuity,” says Kelly Crane, senior vice president and financial adviser with Wealth Enhancement Group.

Fixed annuities vs. CDs: Penalties

CDs come in different flavors and some, like no-penalty CDs, don’t hit you with a penalty for withdrawing your money before the term ends. But with traditional CDs, there is an early withdrawal penalty that varies depending on the length of the term and the bank or credit union managing the account.

With most annuities, you can withdraw a portion of the fund (usually up to 10 percent) per year without incurring a penalty. But for fixed annuities, fees in the form of surrender charges often come into play, and you’ll be charged for pulling out funds within a certain time frame after investing in an annuity. You could easily end up with a penalty just by not understanding the terms of your contract, Bibbo says.

Making the decision

Anyone planning for retirement has a lot to consider before deciding how to invest their money. Comparing the best rates offered on CDs with those offered on fixed-rate annuities can be a starting point in deciding which is better for your retirement portfolio. Other factors to consider include taxation as well as fees and potential penalties. If you’re not an expert in money matters, a financial advisor can help you decide what’s the best place for your retirement fund.

– Amanda Dixon contributed to an earlier version of this article.