When putting together a retirement portfolio, it’s a good idea to include different types of assets for diversity and to reduce the risk associated with your portfolio. During unsettled times, many people turn to cash for their retirement portfolios. One way to add cash to a retirement portfolio is to invest in CDs.
CDs and Your Retirement Portfolio
You might not be able to hold a CD in the retirement account offered through your work. However, it is possible to hold a CD in an IRA. If you have an Individual Retirement Account (and any American with earned income can open an IRA), you can check with your custodian to find out if you can add a CD in order to boost your cash holdings.
If you keep a CD in your IRA, it takes on the tax advantages that come with an IRA. If you have a Traditional IRA, the interest earned from your CD isn’t taxed until you withdraw it during retirement. If you have a Roth IRA, you won’t have to worry about paying tax on your interest earnings at all, as long as you withdraw your money in accordance with the withdrawal rules of the Roth IRA.
This can be a small advantage, since you normally pay taxes on interest earned from CDs in the year that it is paid to you. If you keep the CD in a tax advantaged IRA, this isn’t an issue.
The Role of CDs in a Retirement Portfolio
For those looking for a little cash to help prop up a retirement portfolio through diversity, CDs aren’t all bad. Additionally, if you can purchase CDs during times when the market is doing well and the yield is higher, the interest from your CDs can provide income during your retirement.
Some retirees like to build long term CD ladders to provide them with income. However, this only works if you already have a large nest egg and can divide your CDs into jumbo CDs that are large enough that the interest earned (and paid out) is significant enough to actually provide income.
While CDs can serve as part of a backstop in a portfolio, they are not ideal for the wealth building phase of your retirement. The interest yield on CDs is so low that you might actually be losing money, in real terms, to inflation. You aren’t going to build up a nest egg when you are lucky to earn between 1% and 1.5% on your CDs. Even during a high interest rate environment, CD rates rarely go much beyond a 5% or 6% yield. That can be a respectable return, but it will be many, many years before CDs ever return that much again — if they ever return that much again.
In general, cash just isn’t the best choice for a retirement portfolio, particularly during the accumulation phase. While there is a place for cash assets like CDs in a long term retirement plan, it’s important to carefully consider the situation and figure out how CDs are most likely to fit in at different stages.
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