Annuity vs. CD: What’s the Difference?

What Is an Annuity?

An annuity is an investment product offered by insurance companies that makes fixed payments to you in exchange for premiums you've paid. They are complex because there are many different types available, with varying interest rate and payout structures. You can choose an immediate annuity, in which you'll start receiving payments one year later at most, or a deferred annuity, in which you start getting income multiple years later, typically in retirement.

Alongside immediate and deferred annuities, here are the other types of annuities:

• Fixed annuity: Your investments earn a specific interest rate, which could change periodically, until the payout period. When you start receiving income from the annuity, you'll receive a fixed amount for the whole term.
• Variable annuity: Your investments earn a variable rate of return, which can change based on market conditions during the accumulation period. During the payout period, you'll receive income that's either fixed or variable, and could be more or less than you expected based on how your investments performed. You can choose to add a death benefit, which will provide a beneficiary a certain payout.
• Indexed annuity: Also known as a fixed index annuity, this type bases your investment return on two interest rates: a minimum guaranteed rate and an interest rate tied to the market. Indexed annuities are riskier than fixed annuities but likely safer than variable annuities. Returns can vary greatly depending on the indexed annuity's features and the index it's linked to.

Learn more: Types of Annuities to Know

What Is a CD?

A CD is a type of low-risk investment account provided by banks, credit unions and brokerages that offers a higher rate of return than a traditional savings account. To get access to this higher rate, you must leave your money locked in the account for a certain period of time, typically three months to five years. If you withdraw money early, you'll pay a penalty that's equivalent to a certain number of days' worth of interest. Often, the longer your term, the higher the penalty you'll pay.

Learn more: What Is a CD?

Annuity vs. CD

While both annuities and CDs can provide reliable returns on your money, they differ in a number of ways. Most significantly, annuities are typically a retirement savings vehicle that provides guaranteed payments for a long time frame. CDs have shorter terms and are a better option for other savings goals, like preparing for a home renovation or wedding.

Annuities can come with fixed, variable or indexed interest rates. But some annuities, like variable annuities, don't guarantee you'll earn a specific return during the payout period, and you could lose some of the money you initially invested. Meanwhile, CDs traditionally have fixed interest rates, which provide a clear likely return at the end of the term. But there are also CDs with one-time rate increases (bump-up CDs) and with variable rates (some step-up CDs).

When it comes to risk level, annuities are high risk compared to CDs, which are one of the top low-risk investments. Annuities have high fees, complex rate and term structures and lack of FDIC insurance. CDs provide a specified rate of return that lets you guarantee growth, plus they are FDIC insured.

Should You Get an Annuity or a CD?

Annuities and CDs are very different financial products that help investors work toward varying goals. Here's when it makes sense to choose each.

When to Get an Annuity

You might choose an annuity when:

• You want a guaranteed minimum income. The primary benefit of an annuity is receiving guaranteed income for life, and potentially for your spouse or beneficiaries when you die. You could consider investing in an annuity as a way to ensure you earn a certain income in retirement, alongside Social Security benefits, while your other investments may change in value with the market.
• You're willing to closely evaluate fees and terms. Annuities are particularly complex. You should be open to looking closely at all the features and fees of each annuity you consider, and asking your insurance agent lots of questions. Ensure you understand how your money will grow, what you'll receive as a payout and how fees can impact it.

When to Get a CD

A CD may be a better option in these scenarios:

• You need access to funds sooner. A CD is a wise choice for any savings goal that you might need money for within the next five years, like a home or car down payment. You can renew your CD or roll the money into a new one and continue saving. For long-term goals, you could potentially earn higher returns with higher-risk investments.
• You're already saving for retirement elsewhere. If you currently save in a tax-advantaged retirement account like a 401(k) or an IRA, you can choose a CD as a way to diversify your portfolio. You'll get access to medium-term liquidity when the CD matures, letting you decide whether to reinvest the money, cash it out or put it into a higher-risk, higher-return investment.

The Bottom Line

Both annuities and CDs give you the option to invest money with a certain measure of predictability. But annuities are a longer-term savings option that include many different permutations, making them a more complicated account type with more potential pitfalls. CDs are best if you're saving for up to five years; if you want to invest for a longer period, choose an investment strategy that lets you meet your goals while taking on the amount of risk that's best for your age and risk tolerance.