Why rates differ between deferred annuities, savings accounts and CDs.

Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York

As you approach or live in retirement, you're probably looking for the best place to put your money that's secure but with the highest interest rate. Until recently the interest rate environment hasn't been too friendly for folks like you. While interest rates in general have bounced up, you may still wonder why there is such a difference between savings accounts, certificates of deposit (CDs) and deferred fixed annuities. This is a question we hear often from advisors and members. Read on to learn more.

Recap of savings accounts versus CDs versus deferred fixed annuities.

Savings Accounts

Savings accounts typically offer lower interest rates than CDs or fixed annuities because they provide greater flexibility for account holders to make withdrawals and deposits without penalty. Savings accounts are often used for short-term savings goals, emergency funds or for keeping cash on hand. Banks can afford to offer lower interest rates on savings accounts because they have more flexibility to use the deposited funds for lending or other investments.

CDs

CDs, on the other hand, generally offer higher interest rates than savings accounts because they require the account holder to commit to leaving the money in the account for a fixed period of time, typically ranging from a few months to several years. This commitment reduces the liquidity of the funds and allows the bank to use the money for longer-term investments or loans. In return for the account holder's commitment, the bank offers a higher interest rate. CDs are often used for medium-term savings goals, such as a down payment on a home or a child's college education.

A lot of people hold savings accounts and CDs as an effective way to accomplish their goals for safety and liquidity. The tradeoff to secure and easy access to funds is the rate of return may be lower than what you might receive with a deferred fixed annuity.

Deferred fixed annuities

Deferred fixed annuities are insurance products designed to help you accumulate money for retirement. Typically, you put money into the contract and the interest rate is guaranteed^{See note1} for a period, such as five years. After that, the money and accrued interest is available for use, or if the funds are kept in the contract, a new rate will be set for the next guaranteed period. In addition, deferred fixed annuities offer tax-deferred growth, meaning that the account holder doesn't have to pay taxes on the interest earned until they withdraw the money. Since they may be harder to access before age 59½, annuities are generally thought of as long-term commitments for retirement use.

There are lots of different types of annuities, but many people who are trying to decide between an annuity and a deposit account are considering deferred fixed annuities. While they may offer lower interest rates than other types of annuities, they appeal to people with a low risk tolerance.

So, what causes rates to vary between bank deposit accounts, such as savings accounts and CDs, and deferred fixed annuities?

Factors that affect interest rates.

Time to maturity

In the cases of CDs and deferred fixed annuities, it's generally true that the longer the time until maturity, the higher the rate offered. Although both may be linked to treasury rates, that doesn't tell the whole story.

Banks and other CD-issuers may base their rates on benchmarks, such as the federal funds rate.^{See note2} Deferred fixed annuities, on the other hand, are generally backed by fixed-income assets like bonds, which typically have longer maturities and crediting rates that follow closely to bond and treasury rate movements.

You can view current USAA Fixed Guaranteed Growth (FGG) deferred annuity interest rates here.

Although interest rates may be a key differentiator between CDs and deferred fixed annuities, there are other important factors to consider before you commit to an annuity.

Safety of principal

Both CDs and fixed deferred annuities are considered to carry low risk to your principal. But there is a difference in how your principal is protected. The Federal Deposit Insurance Corporation (FDIC) insures CDs issued by a bank for up to $250,000 per depositor per FDIC-insured bank, per ownership category. Should the bank fail, the FDIC guarantees CDs up to this amount.

Fixed deferred annuities are issued by insurance companies and aren't insured by the U.S. government. They're backed by the claims-paying ability of the issuing insurance company, regardless of the amount. Before buying an annuity of any kind, it's important to consider the financial strength of the issuing company by checking with the major independent ratings companies like A.M. Best, Moody's, Standard & Poor's and Fitch.

Liquidity, penalties and surrender charges

Bank savings accounts are liquid, and you normally have access to your funds without penalties. If you own a CD and need to get your money out before it matures, many banks will assess an early withdrawal penalty.

Some deferred fixed annuities may contain a free withdrawal provision, which allows the contract owner to withdraw a designated portion of their funds, often 10% each year, without incurring a surrender charge. But surrender charges for a deferred annuity can be substantial. For example, the current surrender charges for the USAA Fixed Guaranteed Growth (FGG) 5-year deferred annuity are:

• 9% in year 1
• 8% in year 2
• 7% in year 3
• 6% in year 4
• 5% in year 5

Tax deferral

Interest on a CD is taxable in the year it's earned – unless it's held in an IRA.

But interest in a deferred fixed annuity owned outside of an IRA isn't generally taxed until withdrawal. For nonqualified annuity withdrawals before age 59½, the interest earned on a deferred fixed annuity is subject to ordinary income tax. A 10% penalty on the interest earned may apply as well.^{See note3} If you own either a bank deposit account or a deferred fixed annuity within an IRA, any withdrawals are treated the same by the IRS.

Takeaways

While several factors impact the difference in rates between savings accounts, CDs and deferred fixed annuities, remember that rates can change daily and will vary depending on the institution, the amount deposited and the time to maturity.

For those looking for safety of principal plus a modest return, and with lower costs for early access, a deposit account might be the right choice. For others who can commit their money for a longer-term goal and may not need access to it in the meantime, a deferred fixed annuity may be a viable solution.

To learn more, view current interest rates of the USAA Fixed Guaranteed Growth (FGG) deferred annuity. Start the conversation with a Retirement Income Specialist at 800-531-3392.