CDs

Are CDs the best place for your money?

CDs or Certificates of Deposit

Certificates of deposits are known as CDs. They are a savings vehicle offered through banks, and authorized representatives outside of the bank. A certificate of deposit will offer consumers a stated interest rate for a stated period of time, typically ranging from 3 months to 5 years. The most common choice of consumers when opting for a CD is 1 year. At the end of the CD period, the CD matures, and the principal and interest are paid back to you. If you need to withdraw the money from a bank CD before maturity, the bank will apply a penalty or you may forfeit some of the interest.
at some bank
Are CDs the best place for your money? Sometimes yes, and sometimes no. CDs may be a place where we can put money that we may need 3, 6, or 9 months, from now. However, CDs may not help us reach our retirement goals as well as some alternative investments or savings products may. CDs are simply not as tax-efficient as other financial vehicles. Also, in terms of liquidity, there is no way of reaching in and taking out money that you may need, other than the interest only, and/or, you may be subject to a penalty. You must wait until the CD matures. CDs do not provide the ability to reach in and withdrawal up to 10% of your account value in the event that you need it, as do some other products. Note that some CDs may allow systematic interest withdrawals.

Keep in mind, should you die while owning CDs, your CDs will have to go through the probate process before proceeds will be received by your heirs or beneficiaries. This will cause increases in probate charges and attorney's fees, where some other savings vehicles bypass probate and your money will be paid directly to the beneficiary upon notice of your death.

Day-in and day-out, people may say that one of the top reasons they leave their money in a CD at the bank is because they are afraid of losing their money. Whether they realize it or not, they may be losing money. Consider a hypothetical yield on a CD at 3%. How much do you pay in taxes? Consider the effect on a person in a 28% tax bracket. This person will get a 1099 on their CD interest, meaning they will have to pay taxes on the 3% they earned in interest on their principal. So, a 3% yield minus 28% in taxes gives you a 2.16% yield, almost 1% less than the original interest rate! That means you are losing 28% of your yield to the government via taxes. So, your yield after taxes is now 2.16%.

Inflation is a constant and affects all financial products, but consider a hypothetical rate of inflation of 3%. Subtract 3% from your yield of 2.16% and that would leave you with -.84%, meaning you actually had a negative return of -.84%!

Also, the provisional income formula put into place by congress in 1983 dictates how much of your social security benefits are subject to taxes. It also dictates which savings or investment vehicles are included in the provisional income formula and which are excluded. The net effect of the provisional income formula makes some financial products more advantageous then CDs. Tax deferred growth, within an annuity, does not count toward provisional income, and therefore can reduce the taxes you pay on social security benefits. Investments in CDs increase your provisional income and, hence, your taxes. By repositioning those CDs into a tax-deferred annuity, you can avoid the tax. This is a sound strategy if you have no need for the interest.

Again, are CDs the best place for your money? Sometimes yes, and sometimes no. CDs may be a place where we can put money that we may need 3, 6, or 9 months, from now. However, CDs may not help us reach our retirement goals as well as some alternative investments may, and CDs may lead to paying more taxes on our Social Security benefits.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.