If you are looking for a decent rate for your money, your local bank might not offer much to write home about. We already are in a low-interest rate environment, and the Fed doesn't appear to be ready to raise rates anytime soon.
This is, of course, one of the effects of recent public health and economic conditions, which also might not be winding down anytime soon.
When it comes to earning interest, one option that banks offer is a certificate of deposit.
What Can a Bank CD Do for You?
Certificates of deposit that are issued by a bank always have a set term until they mature. The common maturities are 3 months, 6 months, 1 year, 18 months, and 5 years.
If you have to withdraw some or all of your money before then, then the bank will assess a penalty on the amount withdrawn. The amount of the penalty may equal or even exceed the amount of interest that you will earn.
Some banks will even deduct from your principal in order to cover the cost of the penalty, if necessary, depending on the terms of your CD product.
When your CD matures, your bank will send you one or more notices telling you:
- The date your CD will mature
- What your bank will do with your money if you do nothing (often the CD will renew or roll over to another CD)
- The renewal rate on the new CD (if this isn’t obvious, make sure you find out—the rollover rates could be lower)
- The maturity date for renewing CDs
- The deadline to request an alternative (such as transferring the money to your savings account)
This leaves you with the question of where you can put your money and get a higher rate than what the banks can pay right now.
An Alternative to Bank CDs
Fixed annuities may be a solution that you are looking for, especially if you are trying to save for retirement. These fixed-interest contracts have been around for over a hundred years, and they have historically offered slightly higher growth than CDs.
Fixed annuities are retirement savings vehicles that grow tax-deferred. They are also exempt from the probate process.
In many cases, the money placed inside them is also safe from creditors (this feature varies somewhat from one state to another and also by circumstances).
How Do CDs and Fixed Annuities Compare?
Here is a side-by-side comparison of the features of CDs versus fixed annuities:
|Bank CDs||Fixed Annuities|
|Typically have a shorter term for earning interest (6 months to 5 years)|
Can guarantee short-term interest earnings but also have longer options for earning interest (3 years to 10 years)
|Interest on earnings is taxed each year even when income isn't taken from the CD (unless the CD is held in an IRA)||Interest earnings aren't taxed until money is withdrawn from the annuity, regardless of whether the annuity is inside an IRA or not|
|You can lose gains your CD money when you take early withdrawals, and some banks might take out principal if your interest money isn't enough to pay the penalty||An annuity might give you more liquidity than a CD, including an up to 10% free withdrawal provision, but also have rules for how much you can withdraw|
|Interest rates on a CD tend to be lower than those on a fixed annuity||Interest rates on a fixed annuity tend to be higher than those on a CD|
|Bank CDs are backed by insurance from the Federal Deposit Insurance Corporation (FDIC), with up to $250,000 per CD account||Fixed annuities are backed by insurance companies, which support every dollar in an annuity with a matching dollar of their own money in reserves|
|If a beneficiary isn't named on the account, the value of the bank CD must pass through probate before it can be given out to your loved ones||The value of the annuity doesn't have to be passed through probate in order to be given to your loved ones|
This comparison shows that fixed annuities have a number of advantages over bank CDs.
However, it should be noted that fixed annuities are designed to be long-term vehicles. So, a fixed annuity might align more with your needs if your timeline for your money is two years or greater.
Any money that is withdrawn from an annuity will incur a 10% early withdrawal penalty by the IRS if the annuity owner is under the age of 59.5 (some qualified exceptions may apply).
Like CDs, fixed annuities also come with a maturity period -- or where you have to wait for a certain amount of time for the contract to mature.
Some contracts give you a free withdrawal provision for some liquidity – usually 10% of the contract value. But during the annuity's maturity period, withdrawal amounts above this permitted amount will likely be subject to a penalty charge.
Your annuity withdrawals are taxed as income, unlike CDs with interest earnings that are taxed as income regardless of whether you withdraw the earnings.
Your financial professional can walk you through the pros and cons of fixed annuities and CDs in more detail.
When Considering Annuities vs. CD, Ask These Questions
Here are some questions to ask yourself when thinking through whether to buy a fixed annuity or a CD:
1. Do you want a guaranteed minimum interest rate for your retirement money?
2. Alternatively, do you prefer to have growth potential for your money above a certain rate, but where the growth is not guaranteed?
3. Would you rather pay taxes on your interest earnings now or defer paying taxes on them until a later day?
4. How long do you want to let your money grow? In other words, how long will it be before you need this money again?
5. Are you willing to give up some liquidity in order to have a higher interest rate for your savings?
Evaluate Your Options
These questions can help you to determine which type of instrument is right for you.
If you are just looking to park your money for a set period and then withdraw it and use it for something else, then a CD may be your best bet. If you want to save money for retirement, then a fixed annuity may be what you're looking for.
What if You Want Higher Growth?
Question number 2 warrants further examination. The type of savings vehicle that can pay non-guaranteed interest is known as a fixed index annuity.
This special type of annuity doesn't pay a guaranteed rate of interest. Instead, it pays interest that is based on the movements of an underlying financial benchmark, such as the Standard & Poor's 500 Price Index.
When the index rises in value, the annuity will pay interest based on a preset formula. Your money will thus earn interest that is based on a portion of the underlying index's increase for that crediting period.
If the index falls in value, then you won't earn any interest for that crediting period. But you won't lose any money due to the index drop, though.
Making the Right Choice for Your Financial Goals
Consult your financial advisor for more information about CDs, fixed annuities, and indexed annuities. With their guidance, you can evaluate your options and decide whether they are right for you. Taking the time to investigate this matter just might get you more bang for your buck in the long run.
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