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Both bank Certificates of Deposit (CDs) and fixed annuities are popular for safe, interest-bearing growth – but they have some differences in rates and tax treatment. Recently, rising interest rates have benefited both: fixed-rate deferred annuity sales more than doubled to $112.1 billion in 2022 (a 111% increase from 2021) as savers flocked to lock in higher yields. Traditional bank CDs also saw a huge resurgence – balances in “small” CDs (under $100k) held by banks, which had nearly dried up during years of ultra-low rates, surged from practically zero in early 2022 to about $1.19 trillion by August 2024. This shows how both instruments became more attractive when interest rates rose. Fixed annuities often offer higher yields than comparably-termed CDs, especially on a tax-adjusted basis, because annuity interest grows tax-deferred. For example, at one point a tax-deferred annuity credited 2.75% for an investor in the 32% tax bracket, which would require a 4.04% rate in a taxable CD to net the same after-tax return. Unlike CDs, annuities do come with longer commitment periods (surrender charge periods) and IRS rules (like the 59½ age rule for withdrawals). But many retirees use fixed annuities as a “CD alternative” for the potentially better rates and tax advantages – especially if they don’t need liquidity for a set number of years.

Variable annuities (VAs) offer market-driven growth and optional lifetime income guarantees, but they come with higher fees and risk compared to fixed annuities. It’s important to know the cost structure: a typical variable annuity has an annual Your Guide to Indexed Annuities mortality & expense (M&E) insurance fee of roughly 1.3%–1.6% of your account value. On top of that, the underlying investment funds (subaccounts) have their own expense ratios (often ~0.5%–1% or more), and any elective riders (like guaranteed lifetime withdrawal benefits) might add another ~1%. All in, many VA contracts have total annual fees around 2%–3% of the account – an amount worth weighing against the benefits. On the plus side, VAs provide tax-deferred investment growth and can offer guaranteed income or death benefits that mutual funds alone do not. But market exposure means your account can fluctuate – e.g., a downturn like 2008 would reduce the account value (though guarantees can protect income or death payout levels). Perhaps as a result of cost and market risk, fewer people are buying traditional VAs than in the past: sales of variable annuities have fallen from about $184 billion in 2007 to roughly $62 billion in 2022. Many investors have instead gravitated to buffered annuities (RILAs) or indexed annuities for some market participation with less downside, or to lower-cost investment products. In summary, a variable annuity can be valuable if you desire market growth and insurance guarantees in one package – just be mindful of the fees and ensure the benefits align with your needs.

Annuities are designed as long-term retirement products, so there are rules about accessing your funds. During the surrender period (which typically lasts a set number of years after purchase), most contracts let you withdraw up to 10% of the account per year without penalty, but taking out more incurs a surrender charge. Additionally, the IRS imposes a 10% additional tax penalty on withdrawals taken before age 59½ from an annuity (except in certain special cases). This is similar to the early withdrawal penalty for IRAs/401(k)s and is meant to discourage tapping your retirement nest egg too soon. The flip side is that annuities enjoy tax-deferred growth – you don’t owe taxes on interest or investment gains until you withdraw the money. This tax deferral can significantly boost growth over time. For example, over a 36-year period at a 6% annual return, a tax-deferred investment grew to about $800,000 before withdrawal; even after paying taxes on a lump sum, it netted roughly $569,000, compared to only about $400,000 if the same investment had been in a taxable account all along. In that scenario, tax deferral provided roughly 42% more after-tax wealth than a taxable investment. When you do start withdrawals, gains are taxed as ordinary income (just like IRA distributions). Annuity payouts can also satisfy required minimum distributions if held in an IRA. The key takeaway: plan on leaving the money in the annuity until at least age 59½ (and ideally through the surrender term) to avoid penalties, and appreciate the tax-deferred compounding while it stays inside the annuity.

Annuities grow through the power of compounding interest and/or investment returns, and their growth will depend on the type of annuity. A fixed annuity grows by the interest the insurer credits; an indexed annuity earns interest based on an index’s performance (subject to caps or participation rates); a variable annuity’s account value grows or declines with the market investments chosen. Over time, even moderate rates can yield impressive results thanks to compounding. For example, an investment growing at 6% per year will roughly double in value every 12 years (this comes from the “Rule of 72”). So if you put $100,000 into an annuity earning 6%, it might grow to around $200,000 after about 12 years, $400,000 after 24 years, and so on – assuming no withdrawals. Annuities also grow tax-deferred, which means the full interest can continually compound without annual drag from taxes. This can lead to a substantially larger balance over decades compared to a taxable account. It’s worth noting that annuity growth rates often reflect prevailing interest rates and market conditions. For instance, as interest rates rose in 2022–2023, insurers were able to credit higher interest rates to annuity owners – in fact, industry leaders noted that in 2023 annuity crediting rates were significantly higher than the low-rate years prior. On the variable annuity side, long-term growth will mirror market performance; historically, diversified stock portfolios have delivered strong returns over multi-decade periods (the S&P 500’s annualized return over the past 30 years has been around 8%–10%, though future results can vary). The main point: given enough time, the combination of compounded returns and tax deferral can make an annuity grow substantially, helping fund your retirement income later on.

It’s important to understand the costs associated with annuities, as well as incentives like bonus credits, so there are no surprises. Fees in annuities can include insurance charges (for mortality & expense risk, administration), investment management fees (in variables), and rider fees (for optional guarantees). These are typically built into the contract rather than billed separately. Another cost to be aware of is the surrender charge on withdrawals during the early years of the contract. Most annuities have a surrender charge period that usually lasts about 5 to 10 years from purchase. For example, an annuity might start with a 7% charge if you cash out in the first year, then 6% in the second year, and so on until the charge disappears after year 7 (the exact schedule varies by contract). The good news is contracts allow penalty-free withdrawals of a portion (often 10% annually) during this period – you’d only pay a surrender fee if you exceed that free amount or fully surrender the policy early. Now, bonus annuities: some annuities (especially certain fixed indexed annuities) offer an upfront premium bonus, where the insurer adds (say) a 5% or 10% credit to your initial investment. While it sounds like “free money,” these bonuses come with trade-offs. Insurers recoup the cost through features like lower ongoing interest rates or caps on your annuity, and often longer surrender periods and higher surrender penalties to ensure they retain your funds longer. In short, the bigger the bonus, the more likely the other terms are less favorable compared to a non-bonus product. Always compare the effective earnings rate and surrender terms – you may find a standard annuity with a higher rate can outperform a bonus annuity over time. The key is to read the contract charges and conditions carefully: for example, does the bonus vest over time? what are the annual fees? Understanding these details will help you avoid missteps and choose an annuity that truly aligns with your goals.

Annuities can be beneficial for some people and not as suitable for others, depending on financial goals and circumstances. Who typically buys annuities? They are generally purchased by those near or in retirement who want to secure lifetime income or protect their savings. The average age of an annuity buyer is in the early 60s, and the majority of annuities are purchased by individuals between ages 55 and 70 – basically as they approach retirement and look to convert a portion of their 401(k) or savings into a steady, pension-like stream or safe growth vehicle. People with a need for guaranteed income, principal protection, or tax-deferred growth often find annuities attractive. For instance, someone without a pension who is concerned about outliving their money might use part of their savings to buy an income annuity that they can’t outlive. On the other hand, who might not want an annuity? If you anticipate needing full access to your money in the near term, an annuity’s surrender period and IRS age restrictions (59½ rule) could be a drawback – in such cases, keeping funds in more liquid accounts may be better. Also, if you’re very fee-sensitive and comfortable with market risk, you might prefer low-cost investments (though you’d be giving up the insurance guarantees). It’s telling that interest in annuities has been growing as more people focus on retirement security: 51% of workers in a 2022 survey said they are willing to consider turning a portion of their nest egg into a guaranteed lifetime annuity, a notable rise from only 33% in 2018. This suggests that many see value in what annuities provide – especially in an era when traditional pensions are scarce. In summary, those who should consider an annuity are pre-retirees or retirees seeking longevity insurance (income for life), principal protection, and tax-advantaged growth and who do not need the money for other short-term purposes. Conversely, those who might not are individuals with sufficient liquidity needs, or who have other guaranteed income and prefer to invest their assets freely. As with any financial product, the decision should be based on your personal retirement plan: if steady income and safety are priorities, an annuity could be a fitting piece of the puzzle; if flexibility and maximum growth are the goal (and you have other income backstops), you might opt to forego annuities. The good news is that with the help of a financial professional, you can determine whether an annuity aligns with your situation and, if so, which type would serve you best.