3 Reasons Not to Open a CD Right Now, Even With Rates at 5.30%

A man standing in his living room and looking between two pieces of paper held in each hand.

Certificates of deposit (CDs) lock your money up for a specified term in exchange for a fixed interest rate. They can be an excellent way to boost your savings, especially with many of the best CD rates clocking in at around 5%. What’s more, if banks reduce CD rates later this year, as many experts predict, getting a long-term CD now could mean earning high interest at a later date when interest rates are much lower.

But for all their benefits, CDs aren’t the most advantageous bank account for everyone. If you’re not sure a CD is the right investment for you, here are three reasons they might not be.

1. The stock market could make more financial sense

Generally speaking, if you’re investing for a future that’s still a few decades away, you’re going to get better long-term returns from the stock market than CDs. Over the last 50 years, the stock market has averaged annual returns of roughly 10%. Even the best-paying CDs can only promise you a little over 5% for a short term, like six months.

Of course, not every investor will have a 50-year time horizon. Even so, if you’re investing for a goal that’s more than five years away, you might average a better return investing money in a brokerage account than a bank CD.

That said, investing in the stock market is risky; no one can guarantee you’ll get 10% annually for the next 50 years. This is where CDs really shine. Unlike stocks, they can guarantee a fixed rate of return for the length of their terms. If you can’t stomach market volatility right now, CDs could bring stability to your investment portfolio. Likewise, if you have a short-term goal in mind, such as buying a car or going on vacation, a CD with a shorter term could be more prudent.

2. You might need that money in the near future

By and large, the main disadvantage with CDs is their early withdrawal penalties. Getting a CD with a 5.30% APY is fine if you can keep your money locked up for the length of your term. But where you run into problems is with surprise expenses that might force you to cash out your CD before it matures.

Early withdrawal penalties can be expensive. Often, the penalty equals a certain amount of interest, earned or unearned. For example, a 12-month CD may have a penalty equal to three months’ worth of simple interest. If you had withdrawn from this CD one month after opening it, you would still pay three months’ worth, resulting in a loss of your principal.

This makes CDs generally ill-suited for emergency funds. Locking all your savings in CDs might lead to other financial problems, like credit card debt or needing to raid retirement accounts. While certain types of CDs could help reduce the risk of paying penalties, like no-penalty CDs or CD ladders, other bank accounts might better suit your emergency savings. For example, many of the best high-yield savings accounts have APYs comparable to CDs, but with more withdrawal flexibility. Likewise, money market accounts also have great interest rates and may even let you withdraw your funds using checks or a debit card.

3. CDs aren’t always tax efficient

CD interest is taxed as ordinary income and must be reported on your annual tax filing. Likewise, if you live in a state with income taxes, you’ll pay state taxes too on CD earnings too. This makes CDs slightly less advantageous than Treasury bills (T-bills), which have comparable rates to CDs but don’t incur taxes on the state level.

You could avoid this problem by opening a brokered CD in an IRA account. Like other investments held within an IRA, you won’t have to pay taxes on your CD interest. Rather, tax is deferred until you begin taking distributions in retirement, at which point you may be in a lower tax bracket and will thus pay less lifetime taxes.

All in all, CD rates are at levels we rarely see. While they might not suit all investors, certain savers could benefit from their fixed rates and low risks. If none of these three reasons apply to you, check out some of the best CD rates to see how much interest you can earn in 2024 and beyond.

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