Pros and Cons of CDs in Your Retirement Plan

Looking for a safe way to grow your money? If so, you’ve probably come across certificates of deposit—or “CDs.”

CDs are great if you want a very low-risk way to stash some cash for the short term. They’re structured so that you can be virtually certain you’re not going to lose your money (as long as you don’t withdraw early).

Of course, risk and reward are two sides of the same coin—with low risk comes low returns. It's no surprise, then, that CD interest rates are quite low.

In this article, we go in-depth on exactly what you need to know about CDs and how you can use them for financial planning.

We explain what they are, how they work, and the advantages and disadvantages of using CDs as part of your retirement plan. Plus, we've cataloged the best CD rates around the country — check them out at the end of the article!

What Is a CD?

A certificate of deposit is a type of deposit account offered by banks and credit unions. These accounts offer a guaranteed fixed interest rate, meaning your earnings are guaranteed as long as you keep your money in the CD for the specified period of time. CD investments are usually insured.

The Federal Deposit Insurance Corporation (FDIC) insures all CDs opened in an FDIC-backed bank.

The National Credit Union Administration (NCUA) insures all CDs opened in an NCUA-backed credit union. In both cases, your CD is insured up to $250,000 if the bank or credit union becomes insolvent.

How Do CDs Work?

You open a CD for a specified amount of time—the “term.” Terms can range from one month to many years, but you'll typically see CD terms between three months and five years.

Most CDs offer a fixed interest rate. CD rates vary, but they’re usually slightly higher than you’d get with a regular savings account or checking account.

The bank offers you a guaranteed interest rate in exchange for keeping your money in the account until the maturity date (the end of the term).

As a rule, the longer the term you select, the higher the interest rate you receive. If you take your money out before the CD term ends, you’ll usually have to pay a penalty.

Early withdrawal penalties on CDs can often eat up potential earnings, so it’s best to avoid them.

Still, for many CDs, early withdrawals won’t cause you to lose your initial investment. (Of course, CD rules vary by institution, so always check with your institution to understand the penalties or fees that apply to your CD.)

Different Types of CDs

Historically, CDs have been very simple. You earn a fixed interest rate in exchange for keeping your money in the account for a specified period of time.

However, financial institutions are now offering a number of different types of CDs. This wide selection gives savers some flexibility.

Here are some of the most common types of CDs:

Liquid CDs

These offer you the option of withdrawing your funds before the maturity date, with no penalty fees. Because they offer greater flexibility, this type of CD usually offers lower interest rates.

Bump-Up CDs

These let you “bump up” your CD account to a higher interest rate if interest rates rise. They help ensure you don’t get locked in at a low rate of return. Keep in mind that these accounts usually start off with a fairly low rate. If interest rates stay flat or drop, you might end up worse off than if you had chosen a traditional CD. Also, your bank or credit union may not bump up your rate automatically. You may have to contact them each time interest rates change.

Step-Up CDs

This type of CD has a regularly scheduled interest rate increase. For example, your rate might increase every six months. The idea is that the longer you keep your money in the CD, the better your rate will be.

Brokered CDs

These are CDs sold by investment brokers in a brokerage account. They may offer you more CD options, making it easier to shop around for the best rate. On the other hand, be aware that the issuer may not be FDIC-insured. Always look for an FDIC-backed CD. They ensure that if the issuer becomes insolvent, you won’t lose your savings. Additionally, these types of CD may have management fees associated with them.

Jumbo CDs

These are CDs with very high minimum deposits—often around $100,000. Jumbo CDs usually offer a slightly higher interest rate compared to other CDs in the same financial institution. Note, though, that even the Jumbo CDs in one bank may have lower interest rates than the regular CDs in another. That's why it's always best to do your research before purchasing!

IRA CDs

These are simply CDs held inside an individual retirement account (IRA). The IRA gives them some tax advantages, including tax deferral.

CD Ladder

Technically, this isn't a type of CD; it's a CD strategy. With a CD ladder, the depositor divides up an amount of money and deposits into multiple CDs with different maturity dates. For example, you might purchase one CD to mature in a year, another to mature in two years, and another to mature in three years. Laddering helps ensure that your entire chunk of money isn't tied away for long periods of time while still offering the higher interest rates that come with longer terms.

Certificates of Deposit: Advantages and Disadvantages

Certificates of deposit advantages and disadvantages can be critical. Have a look at the different pros and cons of CDs.

CD Benefits

CDs have several benefits over other investment and savings products. Here’s why you might consider opening a CD:

Safety

You’re usually guaranteed not to lose your money as long as you don’t withdraw from your CD early.

Insurance

Opening a CD in an FDIC-insured bank or an NCUA-insured credit union insures your CD for up to $250,000 if the financial institution becomes insolvent. Predictability. You can usually calculate exactly what you’ll earn over the CD term before you open the account.

Modest Growth

CDs usually don’t offer high-interest rates. However, they typically offer APYs (annual percentage yields) higher than money market accounts and regular bank accounts, so you do get some growth.

Flexibility

There is a range of terms available from 1 month to 10 years. You can shop around quite easily for the best rates and the term you want. (Don't forget, we have a list of the best CD rates around the country at the end of this article!)

CD Drawbacks

In addition to the certificate of deposit benefits, there are certainly some drawbacks. Here’s a shortlist of CD disadvantages:

Low Returns

CDs typically have lower interest rates than other low-risk investment options, like annuities.

Inflation Risk

CD interest rates are usually lower than the rate of inflation, which means your money tends to lose its purchasing power over time.

Illiquidity

CDs lock in your money for a specified period of time, and you may have to pay a penalty if you withdraw early. If interest rates rise, you may be locked into a low interest rate.

Is a CD a Good Savings Option?

When considering a CD as a cash management alternative, there are quite a few things to keep in mind. Here are some questions to help you decide if a CD is right for you:

1. Do you have a low risk tolerance? If you have a low risk tolerance, CDs might be for you. CDs grow your money slowly but steadily. They’re best if you want to stash your money away for one to five years and you want a traditional savings option that’s very low risk.
2. Do you want long-term savings? If you’re looking for a long term personal finance option, CDs may not be for you. The reason they aren’t ideal for the long term is that their rates are so low. If you’re looking for a longer-term solution, an annuity might be more appropriate. Annuities are safe investments like CDs, but many insurance companies offer much higher interest rates than CDs. Annuities also have the benefit of tax deferral and give you the option to annuitize and receive steady income in retirement.
3. Do you want very short-term savings? If you want a shorter-term investment option—less than one year—look elsewhere. CDs are not ideal for very short time periods. Instead, you might be better off with a high-yield savings account. Savings accounts provide more liquidity so you can access your money without restrictions. And the slight difference in interest rate won’t matter much over a short amount of time.
4. Do you want high returns? If you want higher risk and potentially higher returns, CDs are not your best bet. Other investment choices (like mutual funds, variable annuities, or index funds) might better fit your needs.

Annuities Are Smart Alternatives to CDs

CDs can be useful, but they have some important drawbacks. So carefully consider the certificate of deposit pros and cons before making your decision. CDs can be useful savings tools, especially if you have a chunk of cash you want to store safely for a few years.

They offer low but steady growth and are very low risk. But for long-term retirement planning, they’re not great. Because their rates are so low, you’d usually be much better off choosing a product that offers better returns.

If you’re looking for low risk and steady earnings over the medium to long term, consider a fixed annuity from Canvas Annuity.

Our products are similar to CDs in that they offer a very low-risk way to grow your money. But they offer better interest rates than CDs, and they are specifically designed to grow your retirement savings. They also offer the added benefit of a guaranteed lifetime income in retirement, which CDs don’t offer. And, they have a number of tax advantages as well. To learn more about annuities and the role they could play in your retirement plan, get in touch with our licensed representatives.

The Best CD Rates Around the USA

Looking for the highest CD interest rates available? We keep an eye on the most recent CD rates because Canvas sells fixed annuities that share a lot of similarities with CDs (but generally have much higher crediting rates). If you’re interested in finding the best CD rates in your state, look for our article on your state.

Note that across the board, the rates for CDs are generally much lower than the best rates for fixed annuities. Contact Canvas Annuity today to learn how much more you can earn in an annuity than a CD!