CD-kind annuities and CDs have been confusing investors over the years because of their similar names. Although similarities exist between the two types of investments, CD-kind annuities and CDs are different investment vehicles which provide different benefits to the individual customer.
CD-kind annuities are fixed annuities which are issued by insurance companies. CDs are issued by edges or brokers. What makes an annuity a “CD-kind” annuity is that the term of the guaranteed rate matches the penalty period of the contract. For example, if a CD-kind annuity is purchased at 3.5% for five years, the holder is guaranteed to receive 3.5% if the annuity is held for five years.
Many other fixed annuities have no maturity date and often only guaranteed the rate of return for the first year of the annuity contract. Usually, the interest rate drops after this initial guarantee period and is then modificated at normal intervals.
Typical rates for CD-kind annuities range from 3 to 10% depending on the contract. A CD-kind annuity can have a contract duration of 1 to 10 years.
CD-kind annuities were originally developed so that people could clearly understand what the rate of return of their investment was. With normal fixed annuities, some investors who did not understand that the guaranteed period was for a limited period of time were becoming frustrated that they were not receiving the payments they were expecting and ultimately paid the penalty fees to get out of their annuity. CD-kind annuities were produced to avoid this situation.
Although they proportion a similar name, CD-kind annuities and CDs are different investment vehicles. Typically, a CD-kind annuity will offer a higher rate of return than a certificate of place. Currently the advantage is about 1% for CD-kind annuities over bank CDs.
CDs are not tax-deferred investments, unless they are held in a tax-deferred investment wrapper. CD-kind annuities are tax-deferred investments. However, any purchaser needs to consider that if the CD-kind annuity is cashed in before the age of 59 1/2 then the IRS will impose a 10% penalty on the gain.
CDs are, however, insured by the FDIC for up to $100,000 if held in a non-retirement account. CD-kind annuities are not insured by the FDIC. There is security, though, for CD-kind annuities. They are covered by individual state reserves. These vary from state-to-state, but coverage usually ranges from $100,000 to $300,000.
Another advantage for CD-kind annuities is that they can be rolled over without claiming the income for tax purposes. This is not possible with bank CDs.
Finally, uncompletely withdrawals are allowed with CD-kind annuities. Most contracts allow customers to withdrawal up to 10% of the annuity without paying a penalty. However, the IRS will charge a 10% penalty, as mentioned above, if the investor is younger than 59 1/2.
CD-kind annuities could be an advantage to an investor, especially if they are older than 59 1/2. They offer a higher rate of return than CDs for the same guarantee period. Also, investors who are retired or near retirement age can avoid the 10% IRS tax penalty on CD-kind annuities.