How to Use (and Not Use) CDs for Retirement
Focus on CDs for cash reserves, use a CD ladder and compare rates. But don’t lose sight of a CD’s purpose.
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Certificates of deposit generally get used as a short-term savings vehicle for goals such as upcoming home or car purchases. If you’re near or in retirement, you might wonder if CDs fit there too.
If you’re risk averse in your investing, CDs can be appealing. Safety is central to them: CDs offer predictable returns, federal deposit insurance and no volatility in value such as in the stock market. In short, they’re reliable and straightforward investments.
But CDs aren’t the most flexible among low-risk savings options. Here are some quick tips for what to do and not do when using CDs for retirement.
Focus on short-term "extra" savings for CDs
Whether you’re near retirement or not, an emergency fund tends to be the most important goal for short-term savings. Having three to six months’ worth of living expenses, or more, in a regular savings account tends to be a common recommendation. CDs aren’t best for emergency cash because they require locking up a fixed sum for a period, typically ranging from three months to five years.
CDs are more a secondary priority, intended for short-term savings beyond the amount needed for emergencies. CD yields are traditionally higher than what other bank accounts offer, giving them an incentive as a place to leave some money alone within a specific time frame.
Consider a CD ladder
Having a CD’s fixed rate during a high-rate environment can mean steady, solid returns for years. But in exchange, you lose access to funds for the term.
One workaround to keep your money occasionally accessible is a CD ladder. Instead of one CD, you divide an investment into equal amounts and put them into CDs of staggered term lengths, such as one year, two years and three years. Shorter terms work, too: three months, six months and nine months. The idea is that you can access some cash each time a CD matures, while letting the rest of an investment grow.
Do: Compare rates at banks or a brokerage
Your bank’s CDs might be convenient, but they don’t always beat the top CD rates offered by other institutions. Online banks and credit unions tend to have some of the best CD rates, and their opening minimum deposits are often low, such as $1,000 or less. Current high-yield rates are around 4% annual percentage yield for six-month and one-year terms, while longer-term rates such as for three and five years are closer to 3.50%, according to NerdWallet analysis in September.
You can also find competitive yields with brokered CDs, which are issued by banks and available at a brokerage. You need a brokerage account and some understanding of how these CDs work, though. Brokered CDs have the most benefits for savers with a lot of funds planned for CDs. For example, a brokerage can spread funds across multiple banks and credit unions to avoid hitting the $250,000 cap for federal deposit insurance, which protects your money if a bank fails.
Don't withdraw early
You generally can’t redeem CDs early without hassle or cost. At banks, CDs’ early withdrawals often come with a penalty, such as months to years’ worth of interest earned. A bank may let you withdraw interest early from a CD, but you’d lose out on the full amount a CD can earn from compounding interest.
At brokerages, you can leave a CD early by selling, but you risk losing some of the original value if current rates are higher than your CD’s rate.
Once a CD ends, there’s a grace period, typically seven to 10 days long, when you can withdraw the full amount without a penalty. Alternatively, you can consider a no-penalty CD, though rates tend to be lower than for high-yield CDs at the same bank.
Don't forget to pay taxes on interest
For most of the last decade or so, CD rates were at rock-bottom lows and the tax burden for CD interest was minimal. But that’s changed with higher rates in recent years and with those higher yields comes the possibility of a more notable tax impact.
CD interest gets taxed at the same rate as regular income for the year you earned that interest. For example, having $10,000 in a one-year CD at 4% APY would earn you $400 in interest, so you’d be taxed on that $400. However, you can reduce your tax burden with IRA CDs, which are tax-advantaged accounts invested in CDs.
» Learn more about what to know when paying taxes on interest or bank bonuses
Don't put too much money in CDs
The safety of CDs can be attractive, but you don’t want to overuse CDs. The inability to access CD funds means closing yourself off from other opportunities to use that money. A high-yield savings account, for example, might be more appropriate as a continuous option to get a decent rate while not locking up funds.
» Dive deeper: How much money should go into CDs
Another low-risk investment alternative to CDs, money market funds, can have comparable returns with easier access to cash for brokerage customers. And within an investment portfolio, stocks and bonds play bigger roles than cash investments such as CDs do over time. Stocks historically have provided the greatest likelihood for strong returns while bonds balance out stocks’ volatility with more stability. CDs don’t always protect against inflation, which can occur when inflation rises while you’re locked into a lower CD rate.
Don’t rule out CDs for retirement savings — just know when to use them.