Annuities Vs CDs

When it comes to choice of low risk investments that offer a reasonable return, many people find themselves torn between annuities and CDs.

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Annuity / CD Primer

Annuities are financial products, mostly offered by insurance companies, in which the person taking the annuity gives the company offering the annuities a payment (annuity premium), which is invested by the annuity company, guaranteeing the annuity holder an assured flow of income for a lifetime or up to a pre-agreed annuity expiry date. In some types of annuities, the annuity holder makes regular periodical payments to the annuity company, which the company invests on their behalf, and pays the annuity holder a lump-sum payment upon the maturity of the annuity.

On the other hand, CDs (Certificates of Deposit) are a form of time deposit, that is, financial arrangements in which the CD holder deposits an amount of money with a financial institution for a fixed period of time at whose end he withdraws the amount he invested plus the interest (usually pre-agreed) it has earned. The earnings on CDs are typically significantly higher than on usual savings, which can be withdrawn on demand.

As investment options, both annuities and CDs have their unique advantages and disadvantages.

Annuity Advantages

The main advantage that annuities have over CDs is that annuities typically offer higher returns than CDs. Moreover, some of the guarantees available to annuity holders (like the guarantee of a steady stream of income for a lifetime) are not be available to CD holders. The downside of annuities is their relatively higher risk, at least when compared to CDs. As it were, in most cases the guarantees behind annuities are just backed by the strength of the company offering them, and if the company goes under (which is a real possibility in the current recession), the money annuity holders had put into their annuities also go down with it.

CD Advantages

Turning to CDs, the main advantage that CDs have over annuities is the fact that they offer a lower risk than annuities. This is because, legally speaking, CDs are treated as savings whereas annuities are considered to be investments. Consequently, CDs (being savings) benefit from federal deposit insurance which annuities (being investments) don’t benefit from. On the downside though, the returns on CDs tend to be lower than returns on annuities. Moreover, if one opts to cash a CD before its maturity, they are often subject to penalties which can amount to quite significant figures, although most annuities also do charge a ‘surrender fee’ if the annuity holder opts to prematurely exit from the annuity agreement.

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