Bottom Line
Moving the entire 401(k) balance into a CD could bump you up to a higher tax bracket. Remember, too, 401(k) money grows tax-free. Consider keeping one to three years of expenses in cash. Make sure your 401(k) assets align with your goals.
Cons of CDs Explained
Lower returns than other investments: CDs offer limited returns if you want to build wealth. You can often get better returns for your money by putting it into the market and buying stocks, mutual funds, or other investments instead—as long as the market is on an upswing.
If you have enough saved that you only need a small percentage of return on investment, then a CD could be perfect for you when you retire. However, that option probably will not be the case for most people, as they will need larger returns than are typical for bank CD rates.
Not only does an IRA give you significant tax advantages, but it's also an investment account that can potentially earn a much higher rate of return than a CD. However, even the safest investments come with a potential for loss.
Interest earned on CDs is considered taxable income by the IRS , regardless of whether the money is received in cash or reinvested. Interest earned on CDs with terms longer than one year must be reported and taxed every year, even if the CD cannot be cashed in until maturity.
Given their similar tax benefits, both 401(k) plans and IRAs can help you reach your financial goals. A 401(k) is usually better if you have an employer match, plan loans, and discounted investment options. The 401(k) plans are also better for high earners because they don't restrict the tax benefits.
If you're a long way out from retirement, a CD probably isn't your best savings option. Retirement accounts like 401(k)s and IRAs offer tax advantages and potentially higher returns in the long run. Early withdrawal penalties can minimize returns.
One of the primary disadvantages of CDs is the lack of liquidity compared to other types of investments. When you invest in a CD, your funds are typically locked in for a specific term, ranging from a few months to several years.
Orman agrees that CDs aren't ideal for long-term growth but are valuable for specific, near-term goals due to their safety and fixed returns. Orman tells consumers to put their money in CDs only when they have funds to keep them safe for a limited time.
Key Takeaways
CDs insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000 cannot lose money even if the bank fails. However, some CDs that are not FDIC-insured may carry greater risk, and risks may come from rising inflation or interest rates.
In a down market, you could transfer all of your holdings to cash or money market funds, which are safe but provide little to no return. (They may not even keep up with inflation.) This, however, is not typically advised unless you are nearing retirement.
Yes, you can transfer a 401(k) to a CD, but there are some requirements to follow to avoid taxes and penalties. You'll need to make sure to use an IRA CD, which is a retirement account that only allows you to invest in a CD. IRA CDs are CDs that are held in an IRA account, allowing you to save on taxes.
Indirect rollover
Request a distribution from your retirement account. Receive the funds through an IRA distribution, typically by check. Open an IRA CD account with a financial institution. Within 60 days of receiving the funds, deposit the funds received into the new IRA CD to avoid tax consequences.
If you put $500 in a CD for five years, how much would you make? This depends on the CD rate. A five-year CD at a competitive online bank could have a rate of 4.00% APY, which would earn around $108 in interest in five years. A five-year CD with a 1% rate would earn about $26.
CD accounts earn less on average than the stock market and mutual funds. That's the trade-off of getting a guaranteed return versus the unpredictable swings of market investments. When you lock in a CD rate, it might not grow your money enough during high inflation periods when prices are going up.
CDs are one option that can help protect your investment from times of turmoil by providing stable income. The returns gained from these investments usually won't be as high as those provided by stocks but they can serve as a cushion to balance your portfolio and keep it afloat when the market is down in the dumps.
Key Takeaways. Even with its drawbacks, the 401K can be a valuable tool in your retirement toolkit. The tax-deferred growth, employer matching, and compounding interest you can earn over time make it a powerful option—though it's far from perfect.
If you want to transfer money from a 401(k) to a CD without penalty, then a direct rollover is the best option. An indirect rollover puts the burden of redepositing the money into an IRA CD on you. If you fail to do so within 60 days, the IRS can treat the entire rollover as a taxable withdrawal.
Millionaires often diversify their assets and income sources. Mutual funds, stocks, ETFs, annuities, CDs, real estate and even speculative collectibles can all play a role in preserving and growing the purchasing power of hard earned dollars.”
Good alternatives include traditional IRAs and Roth IRAs and health savings accounts (HSAs). A non-retirement investment account can offer higher earnings, but your risk may be higher. Investment accounts don't typically come with the same tax advantages as retirement accounts.
Once you start withdrawing from your traditional 401(k), your withdrawals are usually taxed as ordinary taxable income. That said, you'll report the taxable part of your distribution directly on your Form 1040 for any tax year that you make a distribution.