All You Need to Know About CDs for Retirement

Who Should Invest in CDs and Why

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When you invest money for retirement, it should generate more money for you later, when you are done working. Buying a certificate of deposit, also known as a CD, might be a good choice if you need a specific amount of money to become available at a certain future time with no risk of losing all of your cash. That time should be not too far off, rather than years down the road.

If you are investing for a retirement that is still many years away, CDs might not be the best choice because you run the risk of losing money in the long run due to inflation and taxes.

Learn more about when and why CDs are a good investment choice and when and why they are not.

Key Takeaways

  • A CD might be a good investment choice if you need a specific amount of money to become available at a certain future time with no risk of losing all of your cash.
  • The rate of interest on CDs is often less than the rate of inflation. When combined with taxes on the interest, you can lose money over time.
  • In general, CDs are a good investment if you are in a low tax bracket, want no investment risk, and want to preserve capital.
  • Anyone who needs ready access to their cash would be a poor candidate for long-term CDs.

Risk of Loss With CDs

It is possible to lose money even on a safe retirement investment like a CD, which like other kinds of bank deposits, is guaranteed by the Federal Deposit Insurance Corp. (FDIC).

The rate of interest on CDs is often less than the rate of inflation. When combined with federal and state income taxes on the interest, you can lose money over time in investments like CDs that appear to be safe and secure.

For example, suppose you are considering a $10,000 CD that matures in five years. It pays 3% a year in interest, so it will produce an additional $300 a year.

If you pay taxes at a 25% federal rate and a 5% state rate, you'll owe $90 a year in taxes on the CD interest each year.

If inflation is 3% a year, at the end of the year, you would require $309 to buy $300 of goods and services. But after taxes, your CD would have delivered just $210.

In August 2021, the best rate on a five-year CD was 1.35%.

Planning for Retirement With CDs

If you take the time to design a retirement plan, you should know what minimum rate of return you'll need over the years if you're going to achieve your retirement goals.

If you need only a 4% rate of return to meet your retirement goals, and you can find a CD that pays 4% or more, a CD might be a good choice for you.

In this case, you might be able to create a ladder of CDs that mature on different dates leading up to your target retirement date. Doing so can help you hedge against a decrease in interest rates. And if the CDs don't achieve the rate of return you need to achieve your goals, you will still have a few possible solutions.

You can reinvest in other retirement vehicles as each CD expires, ones that might achieve a higher rate of return. Or you might decide to work longer or find a way to reduce living expenses so you can achieve your goals on the returns offered by your CDs.

CD rates are always changing. As interest rates and your goals change, you can mix up your investment choices to keep pace.

Who Are the Best Candidates for CDs? 

In general, CDs are a good investment if you are in a low tax bracket, want no investment risk, have a primary goal of preservation of capital (as opposed to growing capital), and plan to use the funds at a time that matches the CD maturity date.

It is also important to know whether you can lock in a rate of return higher than the rate of inflation over the time period you need.

For example, if you are in a low tax bracket and don’t need the funds for 10 years, a 10-year CD that pays 5% would be a good investment if you expect inflation to be 3% or less.

If you are in a higher tax bracket, you might consider a tax-deferred or tax-free alternative to CDs, such as Series I savings bonds, fixed annuities, ultrashort-term bonds or bond funds, or short-term municipal bonds or bond funds.

Who Are the Worst Candidates for CDs? 

CDs are likely a poor choice if you believe you would be losing money after you factor in taxes and inflation, have a primary investment goal of growth or steady income, or need to be able to withdraw your money at any time.

CDs are not a liquid investment. You can't withdraw your cash early without incurring penalties. Anyone who needs ready access to their cash would be a poor candidate for long-term CDs.

Using CDs in Retirement

While CDs may not be a good investment for a retirement that is still several decades away, they could be a useful tool once you are already retired or close to retirement age.

Storing money that you don't need immediately in a CD allows you to continue earning interest, which can increase the amount available to you during retirement. And the shorter investment timeline means the interest on your CD is more likely to be able to outpace the rate of inflation.

Other investments that you can use to help your money grow in retirement include high-yield savings accounts, interest-bearing checking accounts, and money market accounts.

As always, when planning for retirement or managing your money while retired, it may be helpful to hire a financial advisor who will understand your particular financial circumstances.