Annuities or CDs – What You Should Consider

“Annuities or CDs?” is a question many folks are asking because interest rates on CDs are the best they’ve been in a long time. In this article, we’ll cover both annuities and CDs to help you better understand which option is right for your current retirement planning strategy.

Wait. CDs? They’re No Good, Right?

We haven’t talked about CDs for a long time. Interest rates weren’t that attractive in past years. Most people were lucky to receive 1% to 2% returns. Clients who want to reduce market risk can, at the time of posting this article, go out and get a 1-year CD at 5.5%, or a 5-year CD at 4.5%.

With returns like this, we have a lot of people questioning why they would put their money into an annuity – especially a fixed annuity.

First, we need to consider putting the funds into the right place for your retirement focused plan. You have a lot of options when investing, including the following three main categories:

1. Growth

You can put your money into growth assets, such as equities, because they have the highest return potential. These assets would include things like ETFs, stocks, and mutual funds.

These funds need to remain in the market for some time and have the risk of volatility. Markets go up and down all the time, and your funds will follow this trend, too. You do have the potential to lose money with equities, but we do have controls in place to limit these potential losses.

2. Safety

If you want to have a good rate of return without the risk of losing money on it, you’re now in the following territory:

• CDs
• Treasury Bonds
• Fixed Annuities

These investment vehicles protect you from market losses, so you don’t need to worry about that, but you may earn less with a fixed option.

3. Cash

Easy money access. If you need liquidity, this is the avenue that you’ll want to choose because it gives you access to the money without penalties when you need it. However, you will not receive a high rate of return.

 Keeping this in mind, we’re going to expand on the second category, “safety”, because that’s where the discussion of CDs vs. annuities really exists.

Interest Rate Risks of CDs and Annuities

CDs and annuities are the “hot topic” right now. Interest rates have gone up due to inflationary measures and banks are now able to offer better rates on CDs than they have in a long time. The Fed’s goal is to tame inflation, and when it does go down, interest rates will also come down.

If you buy a CD today at 5% and allow it to reach maturity, you can choose to:

• Take the money and put it back in a CD
• Take the money out and put it into other investments

CD renewals will allow you to buy the CD again at current market rates. It’s very likely that rates will come down and you may have a CD rate of 3.5% or 4% at renewal – or lower. Two years from now, CDs may be 2% or 1.5%.

These lower interest rates are your “reinvestment risk”.

We like the idea of putting a portion of our client’s money into the six-month or one-year CDs, if they know they’ll use these funds in the next year and will need to access them. In the meantime, they will receive a nice return on their investment.

Fixed Indexed Annuities and Their Potential 

Fixed Indexed Annuities (FIAs) are driven by interest rates, so just like CDs, the interest rates have gone up in the last year. The key difference between a CD and an FIA is the length of the contract you receive. For an annuity, the term is longer, such as 10 years.

You may receive a 4.5% – 5.5% interest rate on CDs for 1 year or more. Over the past 10 years, FIAs with no riders or fees have had returns of 4% – 6%. Compared to CDs, this range for annuities was much higher.

In today’s market, because of higher interest rates you can receive an FIA that averages 5% to 10% over a 10-year period. However, you may have some years with 0% returns.

How does that work?

Annuities are linked to an index. For example, S&P 500:

• S&P 500 rises 10%, so you earn 10%
• Next year, the S&P 500 drops over 10%. Since you are protected from market losses in an FIA, you do not lose any money in that year.

Fortunately, FIAs often have many index options that allow you to diversify your potential and gain more opportunity.

We believe FIAs are really a bond alternative, as they are both conservative and protect against risk. Bonds in 2020 – 2022 hurt portfolios more than they helped.

Clients often look to bonds to make 3% – 5%, but FIAs offer:

• Greater return opportunities
• Principal Protection (protection from market losses)

Of course, if you have money that you want to park for a year and then use the money, put it into a CD and make your 5% return. However, for long-term investments and the potential to make more money, it often makes better sense to go with an annuity.

Annuities are longer-term, but the reward is more consistent. CDs are shorter-term and, while they have their place today, will see rates go back down as inflation falls and interest rates follow.

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