The 6 dos and don'ts of using CDs to prepare for retirement
Over the past few years, the Federal Reserve has raised, and then kept, interest rates high to battle inflation. While this has led to higher costs for borrowers, it has been welcome news for savers — and especially high-yield savings and certificate of deposit (CD) holders.
With CDs, investors can take on minimal risk and earn an attractive rate of return in today's economy. Depending on the term and bank, you can lock in CD rates of over 5% right now that won't charge until the term ends. That means you can enjoy high rates even if CD rates fall.
But while there can be considerable benefits to CD investing, you should make sure to have the best strategy in place to maximize your earnings, especially if you're using CDs to help prepare for retirement.
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The 6 dos and don'ts of using CDs to prepare for retirement
Here are some important dos and don'ts to keep in mind when using CDs to get ready for retirement, experts say.
Do shop around
Like all financial products, CD rates vary by financial institutions. As a result, it's smart to shop around to get the best deal. And, there are certain things to look for outside of just the rate a CD offers, says Jason Dall'Acqua, certified financial planner at Crest Wealth Advisors.
For example, you should be sure to carefully look over the CD terms. Dall'Acqua also recommends paying attention to early withdrawal penalties, which are the fees some banks charge for withdrawing money before a CD term expires, as there are no federal limits on what the penalty amount could be. Therefore, it's important to consider withdrawal fees along with rates when shopping around.
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Do choose a CD term based on your liquidity needs
Experts say to make sure that you also choose a CD term based on how soon you'll need to access the cash for retirement. For example, if you plan to retire in one year and know that you'll need $30,000 in that first year of retirement, then consider parking that amount into a 1-year CD, says Dall'Acqua.
Do consider laddering your CDs
Some experts recommend using a CD ladder strategy for retirement. This strategy involves purchasing CDs with various terms so that they mature at different times, giving you access to portions of your cash at different points.
Robert Johnson, professor of finance at Creighton University, says If you're very close to retirement, you may want to create a CD ladder that provides for the first several years of retirement.
"That is, one could have a five-year CD ladder that provides for the amount of money needed for retirement in each of those years," Johnson says.
Ohan Kayikchyan, a certified financial planner and founder of Ohan The Money Doctor, also recommends using this strategy to prepare for retirement.
When using CDs to prepare for retirement, Kayikchyan says it's essential to ladder them by opting for short- to long-term CDs and considering step-up or bump-up CDs to benefit from rising interest rates.
Do consider buying CDs in tax-deferred retirement accounts
When using CDs for retirement, you should consider purchasing them inside of a tax-deferred retirement account, such as a traditional individual retirement account (IRA) versus a taxable non-retirement account, according to some experts.
"If you're buying CDs [for retirement], do it within a tax-deferred account instead of a taxable account," says Maggie Klokkenga, CFP at financial planning firm Abundo Wealth.
If it's in a taxable account, you'll be taxed on the interest income from the CD at your ordinary income tax rate, says Klokkenga.
Don't put all of your portfolio into CDs
Experts say depositing too much of your retirement portfolio into CDs can be a big mistake because it can lead to missing out on growth in other asset classes like stocks.
"CDs should be used only for the short-term bucket of your portfolio - money you may need within the next one to three years," says Dall'Acqua. "By having too much money in this asset, you could be investing too conservatively for your retirement needs and miss out on long-term growth potential through other investments."
As a result, you could increase your risk of outliving your money.
"If one retires at 65, one may live another 30 or more years," says Johnson. "Putting all of your money into CDs will lead to lower returns and you may find you outlive your retirement savings."
Don't purchase a CD for retirement if you're unsure when you'll need the money
Experts say that if you're not sure when you'll need the money you're depositing in a CD, it may be best to consider other types of savings accounts instead.
"If you are unsure about the time frame that you will need the money, then CDs may not be the best option for you due to their lack of liquidity," says Dall'Acqua. In that scenario, Dall'Acqua says he'd recommend opening a high-yield savings account or money market fund instead.
The bottom line
"CDs can be a great option for investors nearing retirement and want to keep a portion of their money safe that they may need in the next one to three years, but not have it sitting in the bank earning little to no interest," says Dall'Acqua.
However, you should generally avoid putting all of your retirement portfolio in CDs, as doing so can mean missing out on more substantial gains in other asset classes, and in turn, increase your risk of outliving your money. Plus, you may want to avoid purchasing CDs if you're unsure when you'll need to access funds during retirement. In that scenario, a high-yield savings accounts could be better than a CD.
