As you near retirement, it’s natural to want to move your investments to more conservative and accessible pastures. Certificates of deposit, or CDs, offer a very low-risk way to grow your money over time. Additionally, interest rates for CDs are at record highs, making them an attractive option.
Yet CDs aren’t as liquid as other savings accounts or investments, which doesn’t always align with seniors’ shorter time horizon. If you’re a senior considering a CD, here’s what you need to know.
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Understanding Long-Term CDs
A CD is a savings account offering competitive rates higher than you’ll find with most other savings accounts. With a CD, you agree to place your money untouched in the account for a set amount of time — known as the CD’s “term” — in exchange for these higher rates. CD terms range from three months to several years, and generally the longer the term, the higher the rates.
You may face an early withdrawal penalty if you withdraw your money before the term ends. The penalty is usually calculated on the interest earned for a fixed number of months.
Long-term CDs typically come with terms of three or five years. While locking away your money for years in retirement can seem counterintuitive, CDs can be in your retirement plan. They’re an excellent option for those who want stability and are interested in locking in today’s current interest rates.
Advantages of Saving in a Long-Term CD
While putting your retirement funds into a long-term CD is probably not a good idea, they can be a great supplemental option. That’s because you will want to have some money readily accessible as you spend in retirement. Yet once you retire, you should have a fair bit of money saved across different accounts, from retirement accounts like 401(k) to regular savings accounts to taxable brokerage accounts.
You’ll probably want to start withdrawing from your taxable accounts in retirement, giving your tax-deferred money more time to grow. Any extra money you have left over that you don’t need right away? Consider placing it into a long-term CD. This can offer more diversification into your retirement income, protecting you from market volatility and reducing the impact of any one investment on your overall portfolio performance.
As we mentioned before, longer-term CDs typically have higher interest rates than shorter-term CDs. Investing in a three- or five-year CD ensures your money will earn a guaranteed return over that term, assuming you don’t withdraw it beforehand. CDs are very secure, often backed by FDIC insurance, so your money is very safe.
Right now, interest rates are at some of the highest levels they’ve been. It may be smart to lock in those higher rates now. If interest rates fall, the rates on other accounts like high-yield savings and money market accounts will also likely fall. Because CD rates are fixed, you won’t have to worry about that. In this way, CDs can also protect you from market swings, which is a retirement goal for most seniors.
Lastly, sometimes, a CD’s inaccessibility can be a good thing. Making it more challenging to withdraw your money can prevent you from making impulsive decisions and spending too fast.
Disadvantages of Saving in a Long-Term CD
However, there are some drawbacks to consider before you include CDs in your retirement plan.
It’s essential to make sure you won’t need the funds before the CD’s term is up. While unexpected expenses can pop up in retirement, you should ideally have other funds to handle it. If you take your money out of a CD before it expires, you’ll have to pay an often hefty fee, eliminating much of the benefit of having a CD. That’s why a CD isn’t an ideal place for your emergency fund.
Long-term CDs may only be smart for seniors early in retirement. The older you are, the more liquidity you’ll likely need, which means a longer-term CD may not be suitable for you.
It’s also important to remember that depending on the CD you choose, its interest rates may not keep up with inflation, which means the purchasing power of your money will erode over time.
What Seniors Should Know About Using Long-Term CDs
There are some ways to make investing with CDs work for you throughout retirement. One option is to use a CD ladder, which involves investing in multiple CDs with different term lengths. That way, you can take advantage of the higher interest rates that come with long-term CDs, which enjoy the liquidity that comes with shorter-term CDs. When the term of each CD is up, you can reinvest the money into another CD or use it for another purpose.
Besides the term length, there are also different types of CDs. Most savers use traditional CDs, but there may be room in your financial plan for one of these other options:
No-penalty CDs have lower interest rates than traditional CDs but allow you to withdraw your money before the term is up without charging a fee. No-penalty CDs could be a good option for seniors who want more liquidity with their money.
Jumbo CDs require a high minimum deposit but often earn higher interest rates than traditional CDs. If you have a lot of extra cash on hand, you don’t immediately need, this could be a good option.
Step-up CDs come with interest rate increases throughout the term. This allows you to earn more than a traditional CD.
Add-on CDs let you make additional deposits throughout the CD’s term, which may be helpful for savers who want to continue to benefit from a CD’s higher rates.
Alternatives to Long-Term CDs
If you don’t think a long-term CD is correct, some alternatives should be considered. If you’re worried about liquidity, you could opt for a CD with a shorter term length or a high-yield savings account.
If you’re worried about your money’s purchasing power, you could look at other investments like stocks, bonds, exchange-traded funds or annuities.
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Ultimately, it comes down to your financial situation and personal preferences. You’ll also want to consider your retirement savings, risk tolerance and time horizon.
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This article originally appeared on GOBankingRates.com: Is It a Good Idea To Invest in Long-Term CDs if You’re a Senior?