Are you in the market for a certificate of deposit (CD) to grow your savings? It’s a safe option with several terms to choose from. If you select a 5-year CD term, you could earn a generous return on your money.
This guide dives into the specifics of CDs along with the factors influencing their rates and how to maximize returns.
What is a CD (Certificate of Deposit)?
A CD is a type of savings account offered by traditional banks, credit unions and online banks. You can earn a guaranteed return on your money in exchange for letting it sit in the account for a predetermined period, ranging from a few months to several years.
You can expect higher rates of return compared to regular savings accounts. The downside is if you need to access funds before the term ends, you’ll incur an early withdrawal penalty.
The Importance of CD Rates
It’s vital to assess the rates on the CDs you’re considering. They determine how much interest you can earn over the term – the higher the APY, the better.
Focus on 5-Year Term
A CD with a 5-year term gives your money 60 months to grow effortlessly. Again, you’ll likely earn a generous return. But you want to ensure you can afford to have the funds locked away for that long to avoid costly penalties. Otherwise, a shorter-term CD is more ideal.
Factors Influencing 5-Year CD Rates
The state of the economy, along with Federal Reserve policies, competition amongst banks and the inflation rate impact the APYs offered on 5-year CDs.
Economic Conditions
When the economy is thriving, banks and credit unions generally offer higher APYs to attract more deposits from consumers. That said, economic downturns typically mean the opposite, as financial institutions tend to curb costs and scale back on lending activities.
Federal Reserve Policies
The policies implemented by the Federal Reserve also play a role in the returns offered on CDs. Rate hikes that are issued to control inflation often mean higher CD rates. But when the Fed does the opposite and slashes rates, you might see lower-than-expected returns on your CD.
Bank Competition
Banks and credit unions sometimes compete for deposits and sweeten the deal through more attractive rates and terms. It’s particularly common for online banks to offer higher APYs, as they have lower overhead expenses and can pass these cost-savings on to consumers through better rates.
Inflation Rates
Inflation rates are another key factor in CD interest rates. When inflation is high, banks might raise CD rates to offer a real return after accounting for rising prices. However, when inflation is low, CD rates might not rise significantly. As inflation can erode the real value of your returns, keeping track of inflation trends can help you assess whether the rate offered on a 5-year CD will preserve or grow your funds.
Comparing 5-Year CD Rates
When evaluating 5-year CD rates, pay attention to the national averages and offerings of top banks – whether brick-and-mortar or online.
National Average Rates
According to recent Bankrate data, the average yield on 5-year CDs is 1.4%. However, it’s possible to earn far more by doing your homework to identify options that pay far more competitive APYs.
Top Banks Offering 5-Year CDs
- BMO Alto: 4.00% APY
- Synchrony Bank: 4.00% APY
- Andrews Federal Credit Union: 3.90%
- Marcus by Goldman Sachs: 3.80% APY
- Salle Mae: 3.75% APY
- First Internet Bank: 3.67% APY
- Alliant Credit Union: 3.65% APY
- EverBank: 3.50% APY
- Barclays: 3.25% APY
Benefits of 5-Year CDs
There’s a lot to love about 5-year CDs that can make them an ideal addition to your financial arsenal.
Higher Interest Rates
Again, 5-year CDs usually have higher interest rates than shorter-term CDs or regular savings accounts. Banks and credit unions do this to incentivize accountholders to save over an extended period.
Predictable Returns
Once you open a CD, the rate is fixed and remains unchanged for the duration of the CD term. So, you enjoy predictable returns, regardless of what happens in the market.
Safety and Security
Most CDs are federally insured by up to $250,000 in the event of a bank failure. This coverage is offered by the Federal Deposit Insurance Corporation (FDIC) for accounts held at banks. Opening a CD with a credit union is available through the National Credit Union Administration (NCUA).
Potential Drawbacks
As with any savings product, there are also potential downsides to consider.
Limited Liquidity
Although cash is liquid, locking your money away in a CD means you lose that liquidity for five years unless you make withdrawals. Remember, that’s an option if needed, but it will cost you in the form of financial penalties.
Penalty for Early Withdrawal
To add to the last point, early withdrawal penalties apply for premature withdrawals. You may be required to forfeit a sizable portion of interest earned.
Opportunity Cost
Tying your money up in a CD could also cost you greater returns through a different investment vehicle. Or if rates rise, there could be a comparable CD offering more competitive yields.
How to Choose the Best 5-Year CD
Before opening a new 5-year CD, keep these factors in mind to find the best fit.
Interest Rates and APY
The APY reflects the actual annual rate of return, combining the interest rate with the frequency of compounding. Again, a higher APY means more earnings over the CD term.
Minimum Deposit Requirements
Most CDs require a minimum deposit to open an account. You only want to consider options with deposit minimums that work for your financial situation.
Compounding Frequency
CDs compound interest monthly, quarterly, semi-annually and annually. More frequent compounding results in higher earnings over time, so look for CDs with monthly or quarterly compounding to earn more.
Early Withdrawal Penalties
Refer to the fee schedule to determine how much you’ll be penalized if you make an early withdrawal. You want to avoid taking a premature distribution at all costs, but you want to have an idea of the fee if life happens and you need to access funds.
Additional Features
Look out for special features that some banks offer on their CDs. Features like “no-penalty” CDs allow for early withdrawal without losing interest, though they may come with slightly lower rates. Another useful feature could be a rate increase during the term, giving you a chance to benefit if market rates go up.
Strategies for Maximizing Returns
Once your CD is open, follow these strategies to earn even more.
CD Laddering
CD laddering is a strategy that allows you to take advantage of varying interest rates and liquidity. You can do so by dividing your investment into smaller amounts and investing in CDs with different maturities, such as one-year, two-year and up to five-year CDs. This way, one CD matures each year, providing both liquidity and the chance to reinvest at potentially higher rates.
Considerations for Reinvestment
Reinvesting in another 5-year certificate of deposit (CD) may secure a favorable interest rate; however, it is essential to first compare the prevailing interest rates and terms. If interest rates have increased, reinvestment could be a prudent decision. Conversely, if rates have declined, consider a shorter-term CD or alternative savings instruments.
Diversifying Savings Instruments
Besides CDs, think about investing in bonds, savings accounts, or money market accounts. Each of these has distinct advantages, such as different interest rates and levels of liquidity. Plus, balancing your investments among these can minimize risks related to interest rate fluctuations, stabilize your returns and provide cash flow when needed.
Tax Implications
When you invest in a 5-year CD, understanding how the interest is taxed can be crucial for your financial planning. You may pay taxes on the interest as regular income, but using tax-deferred accounts can help reduce immediate tax burdens.
Interest Income Taxation
The interest earned from a CD is considered taxable as ordinary income. This means the total interest will be added to your income for the year and taxed at your federal income tax rate.
The issuing bank will typically provide you with a Form 1099-INT at the end of the year that shows how much interest you earned from the CD. Even if you don’t withdraw the interest, it still counts as income for tax purposes in the year it was earned.
Tax-Deferred Accounts
One way to manage the tax burden from CD interest is by using tax-deferred accounts like an IRA. By placing your CD in an IRA, the interest grows tax-free until you begin withdrawing at retirement. This can be particularly advantageous if you expect to be in a lower tax bracket later.
You can also use a Roth IRA, which, although it is contributed with after-tax dollars, permits tax-free withdrawals in retirement.
Conclusion: Final Considerations and Future Outlook for 5-Year CD Rates
If you’re ready to move forward with opening a 5-year CD, do your homework to find the best available options on the market. Be sure to consider offerings at traditional banks, credit unions and online banks during your search.
The future rates on 5-year CDs will depend on current economic conditions, Federal Reserve policies, competition amongst financial entities and inflation rates. So, if you aren’t quite sure when you’ll invest, keep tabs on market trends so you’ll know when to make a move.
Frequently Asked Questions About 5-Year CDs
You have the option to withdraw the funds or roll them over into a new CD. Some financial institutions automatically renew your CD if they reach out before the term expiration date and do not hear back from you.
No, you generally can’t add funds to a 5-year CD once it’s open. That said, if you want to invest additional funds, you can open a new one and adopt the CD laddering strategy to maximize your earnings.
A 5-year CD may be ideal if you want a safe way to grow your money and can lock it away for the entire term without needing to make a withdrawal. Keep in mind that rate increases could mean you forfeit earning potential.
