Rates on bank certificates of deposit are dismal. The best you can do as of early November 2020 is a mere 0.65% for a one-year CD, 0.85% for a three-year CD, and 1.00% for a five-year certificate, according to Bankrate.com.
While you’re certain to get your money back, because CDs are insured by the FDIC, you’re also virtually certain to lose money after inflation and taxes.
There’s a better way to save money for many people. It’s a fixed-rate annuity — also known as a multi-year guarantee annuity or a CD-type annuity. You can earn up to 2.40% for a three-year fixed annuity and up to 3.05% annually for a five-year contract, according to AnnuityAdvantage’s large database of annuity rates.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Like a CD, a fixed annuity pays a guaranteed interest rate for a set period, usually three to 10 years. There’s no sales charge, so all of your money goes to work for you immediately. The interest is tax-deferred.
While annuities are not FDIC-insured, they are covered by state guaranty associations, up to certain limits, which vary by state. While this is a valuable backstop, the odds that you’ll ever need to rely on the guaranty association are very small. Annuities are issued and guaranteed by life insurance companies, which are strictly regulated by the states to ensure their solvency. This system has worked well.
Besides higher rates, here are the additional ways fixed-rate annuities beat CDs.
Tax-deferral. All CD interest is subject to federal and state income tax annually, even when it’s reinvested and compounded in the CD (unless the CD is in an IRA or other retirement account).
A fixed annuity, on the other hand, is tax-deferred. You won’t receive an annual 1099 and you won’t pay tax on the interest until you withdraw it. At the end of the annuity’s initial guarantee period, you may renew it for another term or roll it over into another annuity.
Tax deferral isn’t an advantage when you hold an annuity in an IRA or other retirement account. However, since you get a guaranteed, competitive rate, a fixed annuity is still a top choice for the portion of your retirement-plan assets you want to shelter from stock-market risk while earning an attractive rate of interest.
For certain retirees, lower taxes on Social Security benefits. About 40% of retirees who receive Social Security pay taxes on at least a portion of their benefits. By moving some of your money from a CD into an annuity, you’ll reduce income that may trigger the tax on Social Security benefits.
Most people who are taxed on their Social Security benefits will profit from this strategy, but not high-income retirees who are well past the threshold. Consult the Social Security website (www.ssa.gov/benefits/retirement/planner/taxes.html) to see how you may be taxed and whether this strategy may work for you.
Greater unpenalized liquidity. Banks impose substantial penalties on all early withdrawals from CDs. Most fixed-rate annuities let you withdraw interest or up to 10% of the value annually without penalty. You will owe income taxes on any interest withdrawn.
Continuing tax deferral and flexibility. Once the fixed term is up, you may renew or can roll over the proceeds into a new annuity of any type and continue to postpone taxes. When you get closer to retirement, you may decide to annuitize the contract. That means you would convert the fixed annuity into an income annuity. You will get a guaranteed lifetime monthly income that begins either immediately or at a future date you select.
One disadvantage vs. CDs. If you withdraw money from your annuity before age 59½, you’ll owe the IRS a 10% penalty on the interest earnings you’ve withdrawn, plus regular income tax on it, as you would at any age. If you’re sure you won’t need the money in the annuity before that age, you’re good to go. If not, it might be wiser to delay purchasing one until you’re older.
This caution doesn’t apply to a fixed annuity in an IRA since you normally won’t take money out of an IRA until you’re past 59½ anyway.
-
Stock Market Today: Dow Dives 1,123 Points After FedMarket participants reacted predictably to a well-telegraphed hawkish turn by the Federal Reserve.
-
Fed Sees Fewer Rate Cuts in 2025: What the Experts Are SayingFederal Reserve The Federal Reserve cut interest rates as expected, but the future path of borrowing costs became more opaque.
-
You've Got a Trust: Now Who Should Be the Successor Trustee?You've set up a trust to protect your assets and your beneficiaries, but you still must choose the right person to execute your wishes. Here's how to do that.
-
Three Ways Fiduciary Financial Planners Put You FirstFiduciary financial advisers are required by law to work in your best interest. Here's how they are key to intentional and efficient financial management.
-
How Long-Term Care Insurance Has Become More FlexibleToday's long-term care insurance offers retirees more appealing options, which can preserve assets and protect the financial stability of a healthier partner.
-
Your Loved One Fell for a Romance Scam: What Not to DoConfronting them probably won't work, but asking them some key questions and urging them to take certain actions could.
-
Three Ways to Help Create Financial Stability for a WidowLoss of a spouse often leads to financial insecurity in retirement. These strategies can help ensure financial stability for the surviving spouse.
-
How to Embrace Personal Growth After a Gray DivorceDivorce at any age is a traumatic event, and resetting psychologically, especially after a late-in-life divorce, is more important than ever.
-
Three 'Yellowstone' Estate Planning LessonsWe can learn a lot from John Dutton's estate planning mistakes. Here are just a few that relate to families in general and family businesses in particular.
-
Claim It Early or Delay? When to Start Taking Social SecurityTiming is everything when it comes to starting Social Security. Here are the top reasons why people choose to delay or take it early, according to one expert.
