There seems to be a competition heating up. It’s always been there. The battle of the CD versus the fixed annuity. Now most of you probably don’t see this as a battle. Most people don’t see this as a competition. Do you think the bans want fixed annuity money? You bet. Do you think the insurance companies want CD money? Definitely.
So I consider it a competition.
Short-Term vs Long-Term
The deciding factor here is you. Short term and long-term are relative terms. Usually short-term is less than 5 years and long-term is longer. This might be different for your personal situation but we’re going to use this guideline today. CDs would then be a short-term investment. I would guess that most people use CDs for 18 months or less. They do however have terms that extend out to 5 years maybe even further. Annuities tend to be used in the 5 to 7 year range. Some companies do offer them for as short a term as 1 year but this is rare in today’s environment. So you might be asking where the competition is?
Have you heard of the hybrid CD?
BusinessWeek has an article titled Investing: Should You Test-Drive a Hybrid CD? Banks are now starting to introduce equity-linked certificates of deposits. The main driving force for this is that rates are just so low on CDs. How do you beef up rates? Apparently you tie them to the S&P 500 and hope for the best. In order to make this work banks will need to use longer term CDs. Mentioned in the article are between 3 and 5 years. The article talks about interest caps as low as 3% with surrender charges as high as 9%. Isn’t this the outrage over Equity Indexed Annuities?
The Industries
It looks like it is going to be a bit of a competition. As a consumer you get to weigh your options. The banking industry or the insurance company. The CDs are FDIC insured, the annuity has a lot higher reserve requirements and a state guarantee fund. The commission of the insurance agents going against the bailout of the banking industry. Do you think either will try to educate you on your decisions or just try and sell you something?
From the early information I’ve seen, the same problems with EIAs will apply to the hybrid CDs: high surrender charges with low and confusing crediting rates. The one thing the bank will hide is commissions. Since they don’t have the traditional sales force of an insurance company the consumer won’t see whose getting paid or be clear on how much they are getting paid. Don’t be confused though, the banks will stand to make plenty of money on these hybrid CDs. If you have a 3% cap or a 20% participation rate guess who keeps the extra money?
There might be another dilemma. An independent insurance agent or financial planner should technically be shopping around to find the best EIA product for the client since commission have become so similar. These could theoretically mean that the consumers are getting more of the better EIAs since they all aren’t created equal. What happens in a bank? There is no independent bankers to do the work for you. It is up to the consumer to do their homework and comparison. The consumer will have to understand the different crediting rates, caps and surrender charges and how they vary from bank to bank. If they just go into ABC Bank all that they will be told about is ABC Bank’s CDs.
Would you rather support a salesman trying to make a living or the infamous banking industry? That’s quite the coin flip. Call it in the air…
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Would you recommend someone under 35 to buy an annuity? Please discuss more about the tax benefits of an annuity.
Thnx!
Hi there. Very interesting post. If it is OK with you, I would like to link back to your article. I think that my readers would enjoy it.
Well that could and might become another post of it’s own. This would really depend on specific situations but it is most likely that I would not recommend an annuity to someone under 35. What reason would they have for the annuity?
You bring up the tax benefits which is that annuities are tax-deferred. We must however, keep in mind that they are LIFO so that the gains come out first and are taxed at ordinary income tax. Then you have to watch out for the tax implications on death. There is no step-up in cost basis and with a non-spouse beneficiary all the gains become taxable to the beneficiary as ordinary income.
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