As of mid-2024, certificate of deposit (CD) interest rates have soared to levels unseen since before the 2008 financial crisis. With yields ranging from 4.00% to 5.00% or even higher, CDs present an attractive option for securing a safe return on retirement savings. However, before committing to this investment route, it is crucial to weigh the benefits and drawbacks to determine if CDs are the right choice for your retirement portfolio.
High CD Interest Rates
The appeal of CDs is largely driven by their high interest rates. A few years ago, it was challenging to find annual percentage yields (APYs) exceeding 2.00%, even for long-term CDs. Today, the landscape has changed dramatically, with yields now commonly falling between 4.00% and 5.00%. This significant increase makes CDs a compelling option for those seeking safe, fixed-income investments.
Safety of CDs
One of the main benefits of CDs is their safety. Covered by FDIC insurance, CDs offer a secure option for storing part of your retirement savings. This insurance guarantees the return of your principal investment up to $250,000 per depositor, per insured bank, providing an additional layer of security for your retirement planning.
Asset Allocation
Despite the attractiveness of CDs, it’s generally not advisable to allocate all or even most of your retirement savings to them, especially if you are more than a decade away from retirement. CDs and other fixed-income investments have historically underperformed compared to the stock market over long periods. By investing too heavily in CDs while young, you may miss out on critical years of long-term compounding potential.
Financial planners often recommend a balanced approach to asset allocation. A common rule of thumb is to subtract your age from 110 to determine the percentage of your retirement savings that should be invested in stocks (or stock-based ETFs and mutual funds), with the remainder in fixed income. For instance, at 42 years old, a suggested allocation would be 68% in stocks and 32% in fixed income, with CDs playing a role in that 32%.
Tax Advantages
Investing in CDs through an individual retirement account (IRA) offers notable tax advantages. While not all brokers provide CDs, many top-rated brokers do. Brokered CDs, which are offered by third-party banks through brokerage platforms, tend to offer competitive interest rates and can help you avoid taxes on your earnings.
For example, if you invest $10,000 in a CD with a 5.00% APY outside of an IRA, you would generate $500 in taxable income over the next year. Depending on your tax bracket, a portion of this interest could go to the IRS. However, by opening a CD within an IRA, all the interest earned remains in your account to grow and compound, deferring taxes until withdrawal.
Regular Strategy Reassessment
Incorporating CDs into your retirement plan requires regular reassessment of your investment strategy. It’s wise to review your income strategy when a CD is nearing maturity, typically a month or two before its term ends. This reassessment allows you to decide whether to renew the CD or reallocate your funds based on current and projected interest rates.
For instance, if you lock a significant portion of your retirement savings into a 5-year CD at a 4.50% APY, this offers a solid yield for now. However, if the Federal Reserve lowers interest rates in the coming years, future 5-year CDs might offer only 2.00% yields, which may not seem as attractive. Many CDs automatically renew unless action is taken, so regular check-ups are essential to ensure your investment strategy remains optimal.
Bottom Line
CDs can be a prudent part of a diversified retirement portfolio, offering a safe and straightforward way to earn a steady return. However, they should not constitute the entirety of your retirement savings. By balancing CDs with other investments, such as stocks and mutual funds, you can achieve a well-rounded portfolio that maximizes growth potential while maintaining a level of safety. With careful planning and regular reassessment, CDs can effectively contribute to a secure and prosperous retirement.
