By Gail Liberman and Alan Lavine

They’re called “CD annuities” because they have terms, much like bank CDs, but often, with higher yields.

The most popular terms for CD-style fixed annuities are 3, 5 or 10 years, and you can find them with yields from 3% to just under 5%. By contrast, don’t expect to earn more than a 3% annual percentage yield with a bank CD these days. It should come as no surprise that with those yields, CD annuities are selling like wildfire. Nevertheless, they can prove riskier than the bank CDs with which you may be more familiar.

“For the first time, I can remember the sales of fixed annuities are bigger than variable annuities,” Mike Farrell, executive vice president of retail sales at MetLife, New York, said recently. “Market turbulence and a flight to safety are driving sales. People want guarantees.”

“The severity of the current recession, which began in 2008, re-ignited customer concerns about their principal’s safety, renewing interest in fixed and indexed annuities,” according to an April 2009 report, published by Conning Research, Hartford, Conn.

Fixed annuities tend to sell well in bear markets, especially when they are able to offer rates that are higher than bank certificates of deposit and Treasurys, observes Judith Alexander, spokesperson for Beacon Research, Evanston, Ill. “They (insurance companies) are able to do this when the yield curve is positive and/or corporate bonds are paying significantly more than Treasurys,” she says.

But before you swallow the bait of a higher yield on CD annuities, you need to understand that they are significantly different from bank certificates of deposit. This even though CD annuities today may be purchased at banks. Bank CDs are insured by the U.S.-backed FDIC to $250,000 per person, while CD annuities are backed only by the insurance company. If a bank fails, your CD contract may be broken and the interest rate slashed. However, you’d be able to withdraw your funds without penalty. You’d always be entitled to your principal, plus accumulated interest—at least to the date of the bank’s failure.

By contrast, if an insurance company issuing your annuity fails, a state guaranty association would back your annuity—at least to $100,000. The state guaranty association would refer to your contract’s “minimum guaranteed rate.” If excessive, it could be adjusted based on a formula tied to Moody’s Corporate Bond Yield Average. But you’d still likely owe surrender charges if you withdraw during the surrender period. With a CD annuity, your money typically grows tax-deferred until maturity. Then, unless the assets are rolled over into another annuity, you’ll owe ordinary income taxes, which can run as high as 35%, on the earnings. With bank CDs, there typically is no tax-deferral of interest.

Beware if you withdraw from a tax-deferred CD annuity before age 59 ½, you not only risk owing surrender charges, but the IRS also levies a 10% penalty. With a bank certificate of deposit, you’re only zapped with a 10% IRS fine if your CD happens to be inside a retirement account, such as an IRA. Meanwhile, a higher interest rate on your fixed CD annuity can signal that your annuity has other wrinkles. Take a popular “market value adjustment (MVA)” feature. While these types of annuities pay higher rates of interest, Alexander says, you assume more interest-rate risk if you withdraw during the surrender-charge period. The value of your principal is based on how a stated interest-rate benchmark, such as Treasurys, has changed since the contract was issued. If interest rates are higher when you withdraw, the account value declines, based on the formula. If interest rates are lower, the account value is greater.

Does your CD annuity have an interest rate “bonus” for a specific period? You might think you add the bonus directly to the base rate to determine your yield. But Alexander notes that the bonus actually is prorated over the term of the contract. “Say you invest $100 in a deferred fixed annuity that promises 5% annually for five years with a 1% first-year bonus. It seems like you’re earning 6% annually. But on average, you’re only really getting 5.2% annually. Of course, you could make a similar mistake with a limited-time bonus CD rate too.” Policyholders also may pay state premium taxes on their purchase. The tax is factored into premium payments.

Many states have been cracking down on the sale of annuities — particularly to seniors. John Catalfamo, president of Primoris Capital Management, a Palm Beach Gardens, Fla.-based tax and money management firm, says he’s met with a lot of seniors, stuck in low fixed rate annuities due to steep surrender charges. In addition, many are unaware they owe taxes on the annuity income when it matures. “We had people come in at tax time that don’t have the cash on hand to pay the income tax on the annuity,” he says. In addition, insurance companies, which guarantee the annuity contracts, have been hitting hard times. It is important to stick with financially strongest insurance companies, rated A+ to A++ by A.M. Best.