As you approach retirement, it’s natural to want to move your investments to more conservative and accessible locations. Certificates of deposit (CDs) offer a very low-risk way to grow your money over the long term. Additionally, interest rates on CDs are at record highs, making them an attractive option.
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However, CDs aren’t as liquid as other savings accounts or investments, and that doesn’t necessarily align with a senior’s short-term horizon. If you’re a senior considering purchasing a CD, here’s what you need to know.
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About long-term CDs
CDs are savings accounts that offer competitive interest rates that are higher than most other savings accounts. With a CD, you agree to keep money in your account for a set period of time (known as the CD’s “term”) in exchange for these higher rates. CD terms can range from three months to several years, and generally the longer the term, the higher the price.
If you withdraw your funds before the end of the period, you may be subject to an early withdrawal penalty. Penalties are usually calculated based on the interest earned over a certain number of months.
Long-term CDs typically come with a three- or five-year contract term. It may seem counterintuitive to keep your money for years after retirement, but you can incorporate CDs into your retirement plan. It’s a great option for those looking for stability and interested in locking in a current interest rate.
Advantages of long-term CD storage
Although it’s probably not a good idea to put your retirement savings into a long-term CD, it’s a good supplemental option. This is because you want to have money that you can use right away in preparation for your retirement. But for retirement, you’ll need to have a sizable amount saved in a variety of accounts, from retirement accounts like 401(k)s to savings accounts and taxable brokerage accounts.
Perhaps you want to start withdrawing money from your taxable accounts in retirement to give yourself more time to grow your money tax-deferred. Do you have extra money left over that you don’t need right away? Consider putting it on a CD for long-term storage. This further diversifies his retirement income, protects him from market fluctuations, and reduces the impact of his one investment on the overall performance of his portfolio.
As mentioned earlier, long-term CDs typically have higher interest rates than short-term CDs. Investing in a three-year or five-year CD guarantees a return over that period, unless you make a withdrawal beforehand. CDs are very safe and are often backed by FDIC insurance, so your money is very safe.
Interest rates are currently at record highs. It may be wise to lock in these high interest rates for now. If interest rates go down, the interest rates on other accounts, such as high-yield savings accounts and money market accounts, will likely go down as well. CD rates are fixed, so you don’t have to worry about that. In this way, CDs can also protect against market fluctuations, which is a retirement goal for most seniors.
Finally, sometimes not having access to CDs is a good thing. By making it more difficult to withdraw money, you can prevent yourself from making impulsive decisions or spending too much too quickly.
Disadvantages of long-term storage on CD
However, there are some drawbacks to consider before including CDs in your retirement plan.
It’s important to make sure you don’t need the funds before the CD expires. Unexpected expenses may arise during retirement, and it’s ideal to have separate funds available to handle them. If you withdraw money from a CD before it expires, you’ll often have to pay high fees and lose most of the benefits of owning a CD. That’s why CDs aren’t the ideal place to store your emergency funds.
Long-term CDs may only be wise for older adults who have retired early. The older you are, the more liquidity you are likely to need, and a long-term CD may not be suitable.
It’s also important to remember that depending on the CD you choose, interest rates may not keep up with inflation. That is, the purchasing power of money is lost over time.
What older adults need to know about long-term CD use
There are several ways to make your CD investments work for your retirement. One option is to use a CD ladder, which invests in multiple CDs with different term lengths. By doing so, you can take advantage of the higher interest rates associated with long-term CDs and enjoy the liquidity associated with short-term CDs. Once each CD expires, you can reinvest the money into another CD or use it for another purpose.
In addition to the length of the period, there are also different types of CDs. Although most savers use traditional CDs, there may be room in your financial plan for one of the other options, including:
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Penalty-free CDs have lower interest rates than traditional CDs, but you can withdraw your money before the end of the term without being charged a fee. Penalty-free CDs can be a good option for seniors who want to increase their financial liquidity.
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Jumbo CDs require higher minimum deposits but often offer higher interest rates than traditional CDs. If you don’t need it right away but have a lot of extra cash on hand, this can be a good option.
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Step-up CDs have interest rates that increase over the term. This allows you to earn more money than traditional CDs.
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Add-on CDs allow you to make additional deposits throughout the term of the CD, which can be useful for savers who want to continue to benefit from CDs’ higher rates.
Long term CD replacement
If you don’t think a long-term CD is right for you, you should consider some alternatives. If you’re concerned about liquidity, you can also choose a short-term CD or a high-yield savings account.
If you’re concerned about the purchasing power of your money, you can also look at other investments such as stocks, bonds, exchange-traded funds, and annuities.
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Ultimately, it comes down to your financial situation and personal preferences. You also need to consider your retirement savings, risk tolerance, and time horizon.
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