I Asked a CFP When It Makes Sense To Get a Certificate of Deposit
A certificate of deposit (CD) is a type of savings account that lets your money compound upon itself over time. They usually have higher annual percentage yields (APYs) than standard savings accounts, so your money can grow more quickly.
The trade-off is that once you deposit funds, you can’t access them again until the CD matures, unless you’re willing to pay a fee. When the CD does reach its maturity date, you get access to the original deposit plus any interest that’s accrued.
Read More: Why More Young Adults Are Choosing Cash Savings Over Investing Right Now
Try This: 11 Subtly Genius Things All Wealthy People Do With Their Money — That You Should Do, Too
As useful as CDs can be, they’re not right for everyone. We spoke with two certified financial planners (CFPs) about when it makes sense to get one, and when it doesn’t. Here’s what they said.
When Getting a CD Makes the Most Sense
If you’re trying to get the most out of your money, a CD can be a way to do that. As per the FDIC, the national rate cap on these accounts ranges from 5.18% to 5.71% APY.
Higher APYs are typically reserved for CDs with longer maturity terms, like three to five years. You’ll likely find lower APYs on shorter-term options.
So when does getting one make sense?
“A CD makes sense when you have a spending event that you know about coming up and you want to earmark that money for the event,” said Chad Gammon, a CFP and the owner of Custom Fit Financial. “An example might be buying a car in 12 to 18 months and so maybe you buy a 12-month or 18-month CD.”
According to Gammon, you might also benefit from having a CD if you’re retired with fixed living expenses, but you also want to ladder your money over a period of time—like one to five years.
“You could buy shorter term CDs like six months to a year and then a two-year and five-year CD as an example,” he said.
If you simply want something with a higher yield than your traditional savings account, a CD could also make sense. Just plan ahead so that you don’t end up needing that money while the account matures.
And When a CD Might Not Make Sense
Certificates of deposit typically have a penalty for early withdrawal. If you’re not sure you won’t need the money during the maturity period (like if your finances aren’t stable) it might not be worth getting one.
“An example is buying a one-year CD and then needing the money in six months,” Gammon said. “You would pay a penalty to get that money out and you would have been better off in a high-yield savings account.”
The early withdrawal penalty varies, but it’s usually calculated based on either:
A portion of the interest earned
A portion of the interest expected to earn
Some combination of both
Depending on the APY, initial deposit, CD term and when you withdraw, you could end up paying hundreds of dollars just for early withdrawal.
According to Gammon, another case where a CD might not be your best option is if you’re planning for something long term, like retirement. In that case, there are likely other saving or investing options that would suit your goals better.
Treasury Bills Might Be Better
A treasury bill, or T-bill, is a short-term debt security backed by the federal government. They also have their own maturity dates and can earn interest. Sometimes, they’re worth getting over a CD.
“I look and compare any CD rate to a comparable Treasury Bill (T-bill),” said Achim von Bodman, CFP and senior tax manager at Watter CPA. “If a CD is paying only slightly better, then I still usually choose the T-bill since it is not taxed at the state and local level. Also, T-bill[s] are backed by the entire U.S. government and not just the FDIC $250,000 for CDs/investments.”
According to Bodman, you’re more likely to get the best rates from local banks than you are from major banks. At the very least, these smaller institutions might have a good introductory rate. Once it ends, you’ll end up with the regular rate, which errs lower.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
More From MoneyLion: