Should You Use a Savings or CD Account for Some of Your Retirement Money?
The cardinal rule about investing for retirement is to keep your hands off your money until you’re retired.
When you invest in your retirement, you’re investing for the long run. You put money in your 401(k) and other retirement accounts with the idea that you’ll be able to ride out the normal highs and lows that come with investing money.
While you should always keep an eye on any of your investments, it’s important to not take money out of your retirement if you see some of your investments lose money. That’s because your annual return will be based on your average return over a period of time.
You give your accounts a chance to rebound and then when you retire, you’ve still made a good return on your investment.
You may be wondering, however, if you should start diverting some of your retirement money to a savings or CD account.
Here are some things to consider.
Interest Rates and Retirement
The Federal Reserve, our nation’s central bank in charge of the money supply, has been raising its target interest rate on a fairly regular basis as of late.
The Fed has indicated a commitment to continue raising the target interest rate as needed in order to curb inflation and keep prices from rising further.
Why Does the Fed Raise Interest Rates?
The intent behind interest rate hikes is to slow the economy. However, it also has some positive effects on your retirement savings.
One of those ways is that the rate you can earn on interest-bearing accounts and products will rise as well.
Just a few years ago, the average rate of interest on a five-year CD was just under 1% but quickly fell by half, and eventually bottomed out at .24%. Rates on CDs are now on the way back up, and many banks are vying for your business by offering some smashing APY deals on CDs and savings accounts.
Comparing Interest Rates
Most retirement savers hold a mixture of stocks and bonds in their 401(k)s and IRAs. These are appropriate for long-term investors because they provide the opportunity for growth that often outpaces inflation over time.
Even the most consistent investments experience gains and losses on a regular basis. You wouldn’t take all of your money out of your retirement account and put it into a savings account if your retirement account goes down because you’re in it for the long run and these indices typically do well.
But what about putting some of your future earnings into a CD account where you could earn up to 3.5% or even more?
How does a CD APY Compare to Other Investment Vehicles?
As with any investment, CD and savings account rates can go up or down anytime based on the interest rate set by the Fed. But when you purchase a CD, you are guaranteed that interest rate for the life of the CD.
This means that if you purchase a five-year CD at 3.7% interest, you are guaranteed to earn this amount on your money.
Does that mean you should shift your retirement savings into things like CDs or savings accounts now? You shouldn’t do it just because rates have moved up. You need to consider how these accounts fit into your retirement plan.
It makes sense to keep a portion of your retirement savings in short-term liquid assets even when the interest isn’t very high.
A cash buffer helps cushion your portfolio from the need to take withdrawals when the market drops as it has done this year.
But some retirement savers have been reluctant to hold very much of their money in liquid accounts when interest rates are low because they feel that they are missing out on better opportunities.
A higher interest rate environment makes holding them a little easier.
Why Hold Some of Your Retirement Funds in CDs or Savings Accounts?
There are some compelling reasons to keep some of your retirement savings in CDs and savings accounts. We explore some of those reasons below.
Protection From Market Volatility
If you’re near or at retirement, even temporary market volatility could be a big concern when you are taking distributions in retirement.
If you hold the entire amount of your retirement savings in market-based investments, you will need to withdraw from an investment even during periods of negative growth.
This won’t necessarily ruin your retirement depending on how large your withdrawals are, but it could if your withdrawals take too much out of your portfolio. Either way, it’s a risk that holding some amount of short-term money can mitigate.
Peace of Mind
There is an added psychological benefit of holding stable investments for short-term money too.
As an example, suppose you held one year’s worth of spending in savings.
Knowing that money is there regardless of what happens can provide you with a significant amount of mental comfort.
Moreover, because you can withdraw from that money you won’t worry as much about what the market is doing in the short term.
This could be the security you need to prevent you from making any knee-jerk or emotional decisions about your other investments that could hurt you in the long term.
Protection From Rising Rates
Rising interest rates can be good for savers in many ways, but they also negatively affect some existing fixed-rate investments like bonds.
That’s because the price of those investments will fall in the secondary market.
Since bonds trade in a competitive market, existing bond prices drop because newly issued bonds will pay a higher rate. The longer the maturity term, the more significant the impact.
As an illustration, suppose you hold a bond that pays 5% interest and has 10 years remaining until maturity.
If the interest rate on newly issued bonds comparable to yours is 6%, the market price of your bond will fall to about $926 assuming it was valued at $1,000 par before the rate increase.
Note that this only reduces the current market price of your bond, not the repayment amount. If you hold the bond until maturity you’ll still be repaid the full principal amount.
Short-term CDs and savings accounts don’t react this way.
The rate on your savings account can increase as rates go up, and as your CDs mature you can reinvest them at higher rates.
Highly Liquid Funds
A simple but powerful reason is liquidity. Long-term investments like stocks, bonds, ETFs, and mutual funds aren’t as liquid as CDs and savings accounts.
To access cash from these investments you first need to sell them. There may be commissions or other transaction fees to make this happen.
There’s also a bid-ask spread. This means the price difference between what securities dealers offer to buy and purchase them for.
Normally, these fees are fairly small for actively traded instruments.
However, you still have to wait for settlement and then transfer the money from your trading account to your checking account.
The expenses, settlement, and transfer delays usually aren’t a huge deal as long as you plan ahead but you still need to consider them.
Cash in savings accounts is instantly accessible. At a minimum, you should keep enough cash in liquid savings to cover emergencies.
Budget and Tax Flexibility
Accounts like 401(k)s and IRAs that are specifically designed for retirement savings are great tools. They shield your investments from taxation which can allow your savings to grow even further.
These accounts should generally be maximized when available.
However, they do have contribution limits.
If you are going to save beyond the capacity of tax-advantaged accounts then CDs or an increased savings account balance could be a good option.
When you have additional savings, it can make sense to hold your short-term money in savings accounts rather than inside the retirement account.
This leaves room in your tax-advantaged accounts for less tax-efficient and higher-interest investments.
Dos and Don’ts of Retirement Savings
As you’re thinking about what to do with your retirement savings, here are a few key things to keep in mind.
Do These Things With Retirement Money
Don't Do These Things With Your Retirement Money
Some Savings Accounts to Consider
MoneyRates reviews savings accounts each month and provides a review that includes the current rate they offer.
Below are some of the accounts we’ve reviewed that offer higher-than-average APYs. You could use this as a starting point for your search.
UFB Direct – Requires a $10,000 minimum deposit, but also offers a higher interest rate as long as you stay above that balance. It offers online banking and charges no monthly fees.
Bread Savings – Simple account with limited features, but offers a good rate with no monthly fees for a low minimum balance of $100.
Citi Accelerate – Offers access to a large network of banks and ATMs in many locations. There is a monthly fee for balances under $500.
Marcus Goldman Sachs – Pays a competitive rate with no monthly fees and requires no minimum balance or initial deposit. One drawback is that your account is only accessible online. It does not provide a debit or ATM card.
American Express High Yield – In addition to a decent yield and no monthly fee, it allows you to link your accounts at other banks to easily transfer cash.
What to Look For in a Savings Account
If you are looking for a savings account to deposit some of your retirement money into, keep these in mind:
Monthly Fees
These can vary widely depending on the financial institution. Some banks may charge a monthly fee if your account drops below a certain minimum amount during the month. Others may not charge a fee at all.
Withdrawals Limits
Each institution may impose a maximum number of withdrawals you can make over a certain period of time. Going over the limit might mean a fee or interest rate reduction.
Accessibility
Does the bank have branches conveniently located in the locations you frequent? What about ATMs? If you plan to access the money somewhat regularly these could be important factors.
Electronic Banking
Does the institution offer this? If the ability to access your account on the go is important to you don’t assume this is available. Make sure to check before you open an account.
Deposit Insurance
A key benefit of deposit accounts is that they are protected by FDIC insurance. This is a federal program that provides up to $250,000 of coverage for you if the bank fails.
Interest Rate
This is probably the first thing you’ll notice. Be sure to shop around and find the most competitive interest rate offered at an institution that provides the features you want.
Methodology
We analyze over 50 financial institutions and products on a regular basis, including savings and CD accounts. We rate and recommend them based on APYs, consistently above-market-average rates, availability, flexibility, number of products offered, minimum balances, fees, user experience, customer service, and more.
