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August 13, 2020
Are CDs Worth It In Retirement?

Are CDs Worth It In Retirement?

Let’s talk about CDs. Not the plastic kind – the financial kind. 

CDs, or certificates of deposit, have been around since 1961, and they’re a popular way for seniors to keep their retirement funds safe from stock market volatility while earning more interest than a regular savings account.

The average 1-year CD rate is 0.21%, while a typical savings account averages at 0.06% (August 2020).

Many seniors are looking for a way to grow their retirement savings without worrying about losing it all in the stock market, and CDs often come up as a great solution. Let’s take a closer look at what CDs are and how they work.

Need Medicare or retirement planning help? The Medicare Allies team specializes in Medicare health insurance as well as retirement planning. Call us today at 833-801-7999 for personalized help.

What Is a Certificate of Deposit (CD)?

A certificate of deposit, or CD, is a savings account that holds a sum of money for a set period of time. For example, you might put $50,000 in a CD for a term of 5 years.

In exchange, the bank agrees to pay you an interest rate. The average 5-year CD rate is 0.43% in August 2020.

When the 5 years are up, you have the option to cash in your CD, and you’d get your original $50,000 back plus the interest, which would total $1,081.28 in our example.

CDs are insured up to $250,000, and they are considered to be one of the safest savings options. CDs can help you manage your retirement income risks.

Common Features of CDs

There are several CD features that are somewhat standard across all financial institutions. 

1. Higher Deposit, Higher Interest Rate

It’s common for banks to reward larger deposits with higher interest rates. 

For example, Bank of America offers a 0.06% Annual percentage yield (APY) for deposits larger than $10,000 while deposits starting at $1,000 only earn 0.03%.

Chase offers a 0.02% APY for deposits under $10,000, but if you deposit more, you can earn up to 0.10%.

2. Many Term Options

You can choose a term from as little as one month to terms as long as 10 years. The longer you park your money, the higher your interest rate will typically be, though not always.

For example, Capital One offers a 0.25% APY for 6-month CDs and up to 1.0% on 5-year CDs.

The most common CD term is 12 months, though many retirees choose slightly longer terms in the 4-5 year range.

3. Insured by the FDIC

CDs are insured up to $250,000 by the FDIC, which is the maximum amount allowed by law. That’s $250,000 total, not per CD.

4. No Touching!

The biggest difference between a CD and a regular savings account (besides the interest rate) is access. If you want to access your CD funds, you will likely be penalized in the form of earned interest.

For example, if you have a 12-month CD and decide to withdraw early, you may be penalized 3 months of interest.

For a CD that’s a 5-year term, it’s common to be penalized an entire year of earned interest for withdrawing early.

Does Your CD Outpace Inflation?

Today, the national average for a 5-year CD rate is just 0.43% (FDIC). 

It’s true that CDs pose no risk of losing your principal, but inflation rates routinely range from 1.5-2.5%. 

Source: Statista; Projected annual inflation rate in the United States from 2010 to 2021 (Published May 7, 2020)

While a CD’s interest rate is almost always better than a regular savings account, the rates usually aren’t high enough to outpace inflation, meaning you are actually losing money over time.

What Happens to CD Rates During a Recession?

CD rates typically fluctuate with the economy. When the economy is booming, CD rates are higher, and when there’s a recession, CD rates tank.

If we look at the national rate for 5-year CDs when COVID-19 hit the United States, they were at just 0.70%. If we travel back to the height of the economy in 2019, 5-year CD rates were over 1.25%.

Can You Lose Money On CDs?

In general, you can’t lose money on a CD. Your principal is protected and insured by the FDIC up to $250,000. There are penalties for withdrawing money before the contract is over, but the penalty is typically earned interest and does not affect your initial deposit.

There are some risks with CDs, including fraudulent deposit brokers and callable CDs. But in most cases, your CD is safe.

Do CDs Have Any Risks?

There are a few risks associated with CDs you should know about, including:

  • Lower returns than you realize: inflation often grows faster than you money, so your real returns are lower than you may realize over time.
  • Penalties: CDs typically don’t allow for early withdrawals, so if you need access to some of your initial deposit, you may be penalized.
  • Fluctuating rates: CDs can have fixed rates or variable rates – variable rates can fluctuate and are not recommended for those in retirement.
  • Unregulated deposit brokers: firms and independent salespeople can offer CDs, but they are not licensed or certified, and no state or federal agency approves them. Anyone can claim to be a deposit broker, so make sure they are legitimate and don’t have a history of complaints or fraud (U.S. Securities and Exchange Commission).
  • Call features: Callable CDs give the issuing bank the right to terminate – or “call” – a CD after a set period of time, but they do not give you that same right. If interest rates fall, the issuing bank might call the CD (SEC).

Is a CD Worth It?

While CDs are insured and the rates are guaranteed, the interest rates are not very attractive.

The national average for an interest rate on a 5-year CD is less than half a percent. 

That’s less than 50 cents for every $100 you deposit. It’s better than nothing, but the CD rate is not outpacing the rate of inflation, meaning you’re actually losing money over time.

This dilemma has caused many retirees to rethink their options for earning income in retirement.

What Is Better Than a CD Account In Retirement?

For clients who have saved up money for retirement, we recommend getting out of the stock market but earning a more competitive interest rate than a CD. The solution is called a fixed annuity.

The most common type of fixed annuity is called a MYGA, which stands for Multi-Year Guaranteed Annuity. You deposit a sum of money for multiple years, and the insurance company guarantees a fixed interest rate in return. That fixed interest rate is typically between 3-4%, a much higher return than a CD.

MYGAs have no fees and are just as safe as a CD from the bank. MYGAs are reinsured up to $250,000, the same amount bank CDs are insured for by the FDIC.

We’ve had clients in the past who were earning 0.6% interest on a bank CD. They came to us and were able to get 5 times the interest by choosing a fixed annuity. They did not sacrifice anything to get it since the kind of annuities we offer are safe and there is no risk of losing any of your deposit due to fees or market volatility.

In fact, they gained important features, like free withdrawals and tax-deferred growth.

The Difference Between Annuities and CDs

CDs and fixed annuities have many similarities, and typically, the higher interest rate of an annuity is the main difference. However, there are a few more features we need to compare side-by-side.

  Certificates of Deposit (CDs) Fixed Annuities
Outpaces inflation
Offers a strong enough interest rate to outpace the rate of inflation
No Yes
Lifetime income option
Offers a guaranteed, predictable stream of payments for life
No Yes – optional
Protects against market losses
Offers a fixed return that avoids market downturns and ensures you never lose money on your principal
Yes Yes
Tax-deferred growth
Offers a way to accumulate retirement funds tax-deferred
No – earnings on CDs are taxable in the year the interest is earned whether you withdraw the money or not Yes – earnings accumulate tax-deferred and are only taxed when you withdraw the funds
Free withdrawals
Offers flexibility and allows you to withdraw a percentage of your deposit without fees or penalties
No Yes
Avoids probate
Offers a way to name a beneficiary, avoiding probate costs and delays
Yes Yes

While both CDs and fixed annuities protect against market losses and avoid probate, the key differences include the interest rate and the ability to enjoy tax-deferred growth.

Conclusion

Many retirees are looking for a safe, guaranteed way to earn interest on their retirement savings. If you’re considering a CD to achieve this goal, we’d recommend comparing it to a fixed annuity

Our clients almost always choose a fixed annuity instead, which allows them to benefit from a much higher interest rate. The ability to access some of your money with free withdrawal features is simply the cherry on top.

Call us at 833-801-7999 to ask about our best fixed annuity rates today.

Luke Hockaday
By
Luke Hockaday
Luke Hockaday is a Customer Success Rep here at Medicare Allies. Luke has been helping Medicare-eligible clients with their insurance and retirement-planning needs since 2011. Luke is passionate about 3 things, and 3 things only: senior insurance, football, and food!

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