When it comes to saving for retirement, most people find their balances stressful. A recent AARP study found that more than half of adults 50 and older worry about not having enough money to support themselves in retirement.
For those looking for relatively “safe” investments, annuities and certificates of deposit (CDs) are two common tools. However, these options are not for everyone and may not be useful for retirement planning.
In this breakdown of annuities and CDs, learn about their rates, fees and returns so you can decide which option is right for you.
A CD is a type of deposit account that you can open at many banks and credit unions. You make a one-time deposit and commit to keeping the money intact for the entire term. CD terms can range from a few months to a few years.
One of the main benefits of CDs is that they typically pay a higher annual percentage rate (APY) than traditional savings accounts. In fact, some of the best CDs today offer more than 4% APY — nearly 10 times the national average APY for savings accounts.
Another benefit is that the rate is locked in for the life of the CD, so you can earn a steady and predictable interest rate and grow your money over time.
However, there is a significant drawback: CDs are not liquid. Your money is locked in for the life of the CD. If you withdraw money before the deadline, you will have to pay an early withdrawal penalty.
Read more: Why a CD should be part of your retirement savings plan
A fixed annuity is a contract between you and the insurance company. With a fixed annuity, the insurance company commits to paying you a minimum interest rate and a fixed amount of periodic payments.
Annuities can be immediate or deferred. With an immediate annuity, you start receiving benefits immediately. A deferred annuity is a popular option for those planning to retire, with benefits starting a year from now.
A fixed deferred annuity has an accumulation period where your payments earn interest at a rate set by your insurance company. There is usually a minimum guaranteed interest rate and a current interest rate; as the market changes, your current rate may change with economic conditions.
Annuity money is tax-deferred, meaning it can grow without affecting your tax bill until you start receiving payments. And annuities are customizable; When you buy an annuity, you can decide how long you want to receive the benefits. You can also specify how the account should be managed after your death. For example, you can sign up for a joint annuity so your partner continues to receive benefits, or you can opt for a single annuity.
For those approaching retirement, investing can be scary. The market can fluctuate a lot, so there is always a risk of losing a large part of your pension fund. That’s why “safe” options like CDs and annuities are so attractive—you can keep your money growing without worrying about market risk.
Before you allocate your money to an annuity or a CD, there are a few key differences between these options to keep in mind.
CDs are opened through banks and credit unions. As long as the financial institution you choose is federally insured, your CD deposits are protected by the FDIC (or NCUA if it’s a credit union) up to a maximum of $250,000 per depositor, per institution, per property class. So there is no risk of losing money if the bank fails.
Annuities are issued by insurance companies and regulated by your state’s insurance commissioner. Annuities are not federally insured. However, state guaranty associations offer protection; state surety associations provide at least $250,000 in coverage per customer, per company, in all 50 states.
CDs are generally less expensive than annuities. They rarely charge monthly or annual fees, and have no commissions or administrative costs.
The only time you have to worry about fees with CDs is when you withdraw money before the due date. If this happens, the penalty for the CD requires the forfeiture of some or all of the interest earned.
Annuities work quite differently. Because they are sold by agents, they include commission. The amount of commissions is usually included in the terms of your contract, but can range from 2% to 8% of the total annuity payment.
Annuities may also have administrative and surrender charges. Transfer fees apply if you withdraw before the contract allows and can be around 10% of the contract value.
CDs are generally easier to open than annuities for those with limited cash flow. Banks can set their account minimums, but you can usually open a CD with less than $1,000.
Annuities require larger upfront investments. Depending on the insurance company that provides the annuity, the minimum amount can be anywhere from $5,000 to $100,000.
With a CD, your rate is locked in for the entire term. Depending on what the rates are at the time you open the CD, this means you could lock in a pretty high rate for a few years.
Fixed annuities typically have two components: a guaranteed base rate and a current rate. The guaranteed rate is fixed for a specific period, such as three or five years. After that, the rate may change with market conditions.
Annuities are deferred, so the money you put into an annuity can grow tax-free. The money is tax-free until you deduct the income.
With CDs, your income is taxed in the tax year in which it is earned.
Read more: How to Avoid Taxes on CD Interest
If you are a few years away from retirement, an annuity may be a better option than a CD because you have more time for your contributions to accumulate interest.
However, if you are nearing or already retired, an annuity hardly makes sense because taxes negate some of the retirement value. Instead, putting money into a CD with a term of five years or less can help you save for shorter-term goals or boost your savings a bit.
However, if you are 10 or more years away from retirement, neither option will be a great place to store the bulk of your retirement savings compared to investing in the stock market. That’s because interest rates on annuities and CDs are typically less than 4%, and the stock market has historically provided an average annual return of about 10%. So you’d miss out on a lot of growth if you only kept your money in CDs or annuities.
Not sure what’s best for you? Make an appointment with a certified financial planner (CFP) or financial advisor to review your finances and create a retirement plan.
Read more: 5 questions to ask your financial advisor before the end of the year