By Shannon Reynolds
Many investors planning for retirement want the guaranteed returns of a certificate of deposit (CD) but don’t want to lose access to their funds for long periods. A CD ladder fits these needs well, providing consistent access to your money while locking in higher interest rates. But it’s not the only option offering this balance of growth and liquidity.
Read on to explore how CD laddering works, how to implement this strategy, and alternatives that offer similar benefits.
A CD is a contract between you and a financial institution, and a CD ladder is a strategy that uses multiple certificates of deposits with staggered maturity dates. With bank CDs, the FDIC or NCUA guarantees the account, making your contribution risk-free up to the guaranteed amount. CDs differ from a savings account because you allow the financial institution to hold your money until maturity.
There are two significant advantages to a CD ladder over a single long-term CD:
If you were to purchase a single CD, you might lock in high returns over the lifetime of the contract, but you lose access to those funds until the maturity date — unless you’re willing to pay the taxes and early withdrawal penalty. A CD ladder allows you to recover a portion of your overall contribution at different intervals.
A savings account gives you free access to your money, but the interest rate is usually far lower than what you typically earn with a CD. That’s because for CDs, the financial institution will pay you a premium to hold your money for extended periods.
Let’s say you want to contribute $10,000 to CDs. If you place all your funds into a five-year CD yielding 5%, you can’t touch any portion of your money until the end without paying a penalty and facing tax consequences. If CD rates increase, you miss the opportunity to get a better return on your contribution.
Imagine you place your entire contribution in a five-year CD offering 5% compounded annually and you don’t access your money until maturity. At the end of the fifth year, your CD will be worth $12,763.
Alternatively, you could divide the $10,000 into five separate CD accounts with different maturity dates:
With this approach, you can access $2,000 of your contribution every year, withdrawing penalty-free or reallocating it to continue building rungs on the ladder. If you don't need the $2,000 at the end of the first year, you can confidently place it into a five-year CD since you know that another $2,000 will become available after the CD reaches maturity at the end of year two.
Note that the rates are different for each CD account in the ladder. As a general rule, a long-term CD will pay a better rate than a short-term CD. At the end of the first year, the $10,000 CD would have earned $500 in interest ($10,000 x 5%). At the end of five years, the CD will earn $12,763.
You can calculate the earnings of the CD ladder by totaling the individual returns:
The total yield after one year is $450. At the end of five years, without reinvestment, the CD ladder will earn $12,463 — $300 less than the single CD.
This may seem like a deterrent, but five years can be a relatively long time frame when it comes to a financial product . The CD ladder allows you to examine your contribution strategy at the end of each year and decide whether you should reallocate your funds, explore other options (like bonds, annuities, or index funds), or wait until interest rates are more favorable.
If you have a long-term financial strategy for retirement, you might be tempted to place all of your savings into a five-year or ten-year CD instead of employing a CD ladder strategy. Here are a few reasons you may want to reconsider.
Life changes rapidly, and many people are uncomfortable with losing access to their money over long periods. With a CD ladder, you can always withdraw — you can structure your CD ladder with quarterly, semi-annual, or annual maturity dates, and then withdraw when they come due.
Financial institutions expect to pay a higher rate for long-term access to your money. CDs typically have better yields than savings accounts — sometimes, two or three times as high. The factors that affect the CD rates include the size of the contribution, the maturity period, and the market at the time of contribution.
If you’re keeping your money on the sidelines waiting for rates to rise, your money might lose value due to inflation. However, if you place $50,000 into a five-year CD yielding 4% and the same product offers 5.25% the next year, you’d still be locked in at the lower CD rate for four years.
On the other hand, if you contributed your $50,000 across CDs with staggered maturity dates a year apart, you can reallocate the one-year CD when it matures. If rates remain high, you can repeat this action every year.
Note, we cannot predict the interest rate environment, and this is known as interest rate risk.
Here’s a four-step guide on structuring a CD ladder that may be right for you — if needed, reach out to your financial advisor for further guidance relevant to their offering.
Decide your comfort level when it comes to maturity dates. For example, many people stagger their CDs with annual maturity dates, but you may be more comfortable with your CDs maturing every six months. Just be aware that the shorter the term, the lower your return tends to be.
Most people choose to portion their contributions equally. In our previous example, we divided $10,000 into five equal portions. However, some strategies call for depositing different amounts into each CD account.
Identify CD accounts with different maturity dates by speaking to your financial institution. The dates should follow a cadence — three months apart, six months apart, every year, etc.
When a CD matures, you can reallocate all or part of the funds to continue the ladder or withdraw the money without penalty. Consider the scenario below:
There are other savings options that can act as an alternative to standard CD ladders. Here are a few examples.
This is a CD ladder for those with short-term goals. Instead of staggering the CDs across long-term maturity dates (or longer-term maturity dates), a mini CD ladder uses shorter intervals. Three-month, six-month, nine-month, and 12-month maturities are common options for a mini CD ladder.
With a bullet CD ladder, all contributions mature on the same date, and you can buy in at different intervals or purchase multiple CDs simultaneously. This contribution strategy may appeal to you if you’re saving for a specific target, like a home purchase or college tuition.
If you’re uncomfortable locking your money into a CD ladder, you could try a high-yield savings account. The interest rates are typically lower than CD rates, but you have unrestricted access to your funds.
An annuity ladder works similarly to a CD ladder, but instead of using staggered CDs, it employs annuities with staggered maturity dates. Many savers prefer annuities for several reasons:
This communication / article is for informational / educational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. The Gainbridge® digital platform provides informational and educational resources intended only for self-directed purposes.
Shannon Reynolds, is an annuity specialist at Gainbridge®
Individual licensed agents associated with Gainbridge® are available to provide customer assistance related to the application process and provide factual information on the annuity contracts, but in keeping with the self-directed nature of the Gainbridge® Digital Platform, the Gainbridge® agents will not provide insurance or investment advice.
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