Bank Saving Products or Insurance Company Annuities, which would you choose for your safe and secure money?
Federal Reserve Vs. 10 Year US Treasury
As consumers, we think of interest as interest. In fact, there are two different and distinct factors that separate banks and annuities when calculating interest on savings vehicles. Bank CD interest rate is calculated on the discount cost of money which is set by the Federal Reserve Board. Bank CD rates are short term rates and subject to the Fed’s rate increase and decrease which can happen at any time it may seem necessary by the board.
Annuity rates are based on the 10-year US Treasury which is a longer vision into interest rates.
Here is an easy way to understand the difference between how interest is credited to the saving vehicles. This of interest like the difference between an ocean tide and an ocean wave.
US Treasuries are like the tides, they ebb and flow slowly
Bank CDs are like waves, quickly up and quickly down
Annuities and CDs (bank certificates of deposit) are similar in that they are safe, secure investments with a guaranteed rate of returns based on interest rates, both issued by large financial institutions, CDs issued by banks, Annuities offered by insurance companies, but they both possess inherent differences as well.
The significant differences are that while Annuities offer many of the same benefits CDs provide, there are several significant differences.
- Generally higher interest rates are available because annuity accumulation times usually are longer
- Tax-Deferral, no tax liability incurred until accumulated funds are touched, earned intere3st is automatically added to the annuity
- Liquidity, generally 10% withdrawal per year with no penalty
- Annuities allow for distribution at the end of the term period that includes income that lasts a lifetime.
- Early access to a Bank CD can cause a penalty, usually loss of interest for 6 months
- In the event of the death of an annuity owner, a named beneficiary would receive the funds without any need for probate.
CDs do have FDIC protection to guard against Bank or banking industry failure, but Annuities also have safety measures put in place by the state to ensure Insurance companies have reserve pools in place. Insurance companies may also be vetted for financial strength by obtaining their rating from outside rating firms — Standard & Poor’s, Moody’s, A.M. Best or Duff & Phelps. The more robust the rating usually equates to a more solid financial backbone of Insurance Company.
Annuities, like CDs, are hinged to interest rates. But when rates are low so are CD returns whereas annuities have a minimum guarantee in place, usually 1% or 2%. Your investment will never dip below the guaranteed minimum interest rate during times of falling or low-interest rates.
Again, low-interest rates mean CD returns will be low as well. To offset the problem of flat or falling interest rates, insurance companies equip annuities with guaranteed minimums. This is an agreed minimum rate of interest so that your investment is assured not to fall below the minimum performance even if CD rates do.
You pay annual taxes on CD interest earned without being able to withdraw funds until your investment term is over. With annuities, there is also a set term, but the earnings are tax-deferred. You only pay taxes on interest earned when money is withdrawn. So with annuities, the deferred tax on your interest remains in the investment earning you more and more money, instead of being paid out to state and federal tax agencies on a yearly basis.
CDs do not allow you to withdraw any monies during the term. Period. Annuities have provisions that would enable you to withdraw money; generally, 10% of your account value annually plus many contracts allow you to remove the earned interest on a monthly basis. Several other contract provisions allow you access to all of your funds such as in the event you are hospitalized, undergoing a life-threatening illness, subject to a permanent or extended stay in a nursing home, or other major calamities that affect you economically. Also, annuities can be structured to pay-out for the life of the owner over a fixed term such as five or ten years, thereby spreading out your tax-burden and providing enhanced income security. In short, Annuities offer enhanced flexibility.