2001-10-17 / Seniors

CDs vs. Annuities: Does The CD

CDs vs. Annuities: Does The CD

Even Have A Chance?

By Robert A. Sagar, CSA

Years ago, before day traders and online brokerages, investors went to their local bank for help. Many investors, particularly seniors, sought security by putting their hard-earned money into Certificates of Deposit. At the time, interest rates were much higher than today’s national average of 4.22 percent on a one-year CD (as of June 26, 2001). Seniors became comfortable and refused to put their "safe money" anywhere else. The most common reason why? "Because it’s right there in my bank."

Seems silly, being that other guaranteed investments offer higher rates of return, tax deferral and other advantages. A Fixed Annuity is the CD’s big bully. Comparatively, competitive annuity rates are always 1.5 percent higher than CD rates, with the best annuities guaranteeing that rate until maturity. And with tax deferral, annuities employ what Albert Einstein called "the magic of triple compounding interest." First, interest is earned on the principal value of the annuity. Second, interest is earned on that accumulated interest. Last, interest is earned on the amount that would otherwise have been paid in income tax had it not been for tax deferral. Obviously 1.5 percent amounts to much more when coupled with triple compounding. If inflation is factored in, CDs will barely maintain value for investors. Let’s assume a 5 percent return on a CD, and assume an investor is in the 30 percent income tax bracket. A one-year CD will net only 3.5 percent. However, with inflation averaging 3 percent each year, that CD will earn only 1/2 percent.

Many investors cite liquidity as the reason they place their assets in CDs. However, banks always charge a penalty on early CD withdrawals. Additionally, the owner generally has only seven days to roll the money over upon maturity. With an average rollover of 18 years, average investors find themselves with only 126 days of true liquidity over 18 years! Annuities, on the other hand, include a 10 percent withdrawal provision per year with absolutely no penalties. And CDs are only guaranteed up to $100,000, whereas annuities are generally guaranteed over $500,000. Which one seems safer now?

In conclusion, the days of the CD are numbered. Being that banks offer only CDs and maybe a handful of weaker annuities that can’t compete on the open market, investors would be wise to look to the independent annuity provider for the "safe money" portion of their portfolio.

Robert Sagar is the president of the Senior Financial Center and a specialist for those 60 and better. He can be reached for any questions or for more information at (800) 618-1825.

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