All You Need to Know About CDs for Retirement

Certificates of Deposit
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When you invest money, it's supposed to generate more money for you later on down the line. Buying a certificate of deposit, also known as a CD, might the perfect investment choice if you need a specific amount of money that becomes available to you at a certain point time in the future and if you want no investment risk. But that time should ideally be not too far off on the horizon, rather than years down the road, as is often the case with retirement.

If you're investing for something like retirement that's many years away, CDs might not be the best choice because you run the risk of losing money in the long run.

Money Loss Risks

How can you possibly lose money in a safe investment like a CD? Taxes and inflation can cause you to actually lose money over time in investments like CDs that appear to be safe and secure.

For example, suppose you're considering a $10,000 CD that matures in five years. It pays 3 percent a year in interest, so it will produce an additional $300 a year. Now assume that you pay taxes at a 25-percent federal rate and a 5-percent state rate. You'll owe $90 a year in taxes on the CD interest each year.

Or, suppose inflation is 3 percent a year. At the end of the year, at a 3-percent inflation rate, it would require $309 to buy $300 of goods and services. But after taxes, your CD delivered just $210.

Certificates of Deposits for Retirement Income

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-percent rate of return to meet your retirement goals, and you can find a CD that pays 4 percent or more, a CD might be a good investment 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. This can 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'll still have a few solutions. You can reinvest in other retirement vehicles as each CD expires, options 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 constantly changing. As interest rates change and as your goals change, be sure to reevaluate your investment choices. It's important to keep pace step-by-step with the economy. 

The Best Candidates for Certificates of Deposit 

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
  • Have a specific use in mind for the funds at a time in the future that matches the CD maturity date
  • Can lock in a rate of return higher than inflation over the time period you need

For example, if you're in a low tax bracket, don’t need the funds for 10 years, you're able to buy a 10-year CD that pays 5 percent, and you expect inflation to be 3 percent, this would be a good investment.

If you're in a higher tax bracket, consider a tax-deferred or tax-free alternative to CDs, such as iBonds, fixed annuities, ultra short-term bonds or bond funds, or short-term municipal bonds or bond funds.

The Worst Candidates for Certificates of Deposit 

CDs are a bad investment if you:

  • Are losing money after you factor in taxes and inflation
  • Have a primary investment goal of growth or income
  • Need to be able to withdraw your money at any time

CDs are an illiquid investment, because you can't withdraw your cash early without incurring penalties and fees. Anyone with liquidity needs would be a poor candidate for long-term CDs. CDs might be a suitable investment for a goal of income in a higher interest rate environment. 

Equity-Linked and Marked-Linked Certificates of Deposits

If you want safety, invest for safety. If you want growth, invest for growth. With an equity CD, you can have the safety of your principal, depending on the terms of the CD, while potentially being able to participate in higher returns if the stock market does well. But bear in mind that the FDIC advises that you use caution when investing in equity-linked CDs. 

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.