Certificates of Deposit, commonly known as CD’s, are a popular form of saving account in day-to-day goals as well as retirement. Their safe and secure nature and easy access make them a prime choice for short-term funds.
CD’s can be purchased through a bank or brokerage. The way these accounts work is that a certain amount of money is deposited and must stay in that account for the agreed upon time. Upon withdrawal, the interest and initial deposit become available to the customer. They are known for short-term savings, usually between six months and five years. Because this is another bank-owned account, it is FDIC insured, and no money can be lost. If the customer does decide to withdraw the funds before the agreed upon time, a fee will need paid and the interest will not be earned.
While, these accounts do not earn as much interest as a mutual fund or stock, they do tend to earn more than other bank-owned funds such as a savings account or money market account. Interest rates will vary depending on the current market and the length of the timeframe. When the bank can count on the funds being available for a longer period of time, they offer a higher rate of return. Interest rates will remain stable over the life of the account which may be to the customer’s benefit or detriment, depending on the market during that time.
To help offset the frustration of missing out on rising interest rates, some banks now offer the ability to raise the interest rate on CD’s once or twice during the agreed upon period. Another common strategy is called laddering, where a person splits the amount between several accounts with different timeframes, such as one for six months, one for two years, and one for five years. As each account expires at different times, the chance is greater that one of the accounts will hold a better interest rate. Bankrate.com lists the current average interest rate for a six-month account at 0.47%, a one-year account at 0.79%, and a five-year account at 1.70%.
CD’s are not tax deferred accounts but act more similarly to a type of savings account. Any money deposited into CD’s will be post-tax and all interest is taxable. Retirement accounts should include CD’s as a person more closely approaches or is currently within retirement. Because no money can be lost and funds can be accessed within a pretty short period of time, these types of accounts can help to continue to grow funds at a moderate rate.
As retirees need more ready access for expenditures, a larger portion of their portfolios should include these secure types of accounts. It will be easier to budget for a year’s worth of expenses without having to wonder whether the volatile market will affect the amount in savings. At the same time, a person should maximize the interest earned during periods of low interest rates by keeping time frames of these accounts shorter and accessing rising rates.