CD Ladder: A Savings Strategy That Uses Certificates of Deposit

Last Updated on July 28, 2021 by pf team

A CD ladder helps to minimize the risk of missed earning opportunities by spreading out your CD maturity dates. Think of laddering as diversification for your CD savings.

CDs can pay much higher interest rates than a standard savings account, however, and a CD ladder can be an effective way to capitalize on higher interest rates while maintaining some access to funds.

Many savers avoid using CDs because of concerns over access to funds. Another concern with CDs is that savers may lose out on potentially higher interest earnings if interest rates increase.

cd ladder
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What Is a CD ladder?

CDs are Certificates of Deposit, which are a type of savings account with a bank or credit union that typically pays a higher interest rate than regular savings accounts.

However, CDs pay a higher rate because you agree to leave the money in the CD for a certain amount of time ranging from 1 month to as long as 10 years.

You’ll find plenty of term options in between, like 6 months, 12 months, or 5 years. The end of the CD term is called the maturity date.

In most cases, CDs with longer terms have higher interest rates, but it isn’t uncommon to find exceptions with shorter term CDs paying higher rates.

A CD ladder is a savings strategy that uses CDs to earn a higher level of interest while providing frequent access to funds and minimizing risk. A CD ladder gets its name because it has steps.

In practice, if you were to view the CD balances in a CD ladder on a chart, it might look like a set of stairs, although depending on how your ladder is structured, the angle of ascent on the chart can be much steeper, like a ladder.

For example, let's say you want to build a one year CD ladder and you have $4,000 to invest in CDs. Your CD purchases could follow this simple structure:

  • 3-month CD: $1,000
  • 6-month CD: $1,000
  • 9-month CD: $1,000
  • 12-month CD: $1,000

Now, you have a simple CD ladder. As the 3-month CD matures, you’ll have the options of taking the money out, rolling the money into another 3-month CD, or to keep the ladder going by buying another 12-month CD.

The longer-term CDs are earning a higher interest rate and with a CD maturing every 3 months, you have reasonably fast access to your savings. More steps can be added to the ladder as well by timing CD purchases for more frequent maturity dates.

Do CD ladders make sense?

Like every financial strategy, CD ladders can be a sensible move given the right circumstances and depending on your goal. To be clear, investing in CDs isn’t the best plan if your goal is rapid growth.

In low-interest-rate environments, CDs will give you a return much lower than the average historical return for the broad stock market.

In fact, when interest rates are low, you may even find that the interest return from CDs fails to outrun inflation or merely keeps pace, preserving your capital but without providing any meaningful growth.

Interest rates go up and down over time, which can affect your overall return from CDs, but each CD typically has a fixed rate. Variable rate CDs may also be available, although they are less common than fixed-rate CDs.

With a mix of CDs purchased at different times or of varying times to maturity, it’s likely that you’ll be earning different rates on each CD.

This can be viewed as the savings equivalent of dollar cost averaging, which is a popular way of investing that places less emphasis on the price of equities and instead focuses on consistent purchases at fixed intervals.

Benefits of a CD ladder

Building a CD ladder brings some new benefits to using CDs that aren’t available with single CDs. Often with a single CD, the temptation can be to buy the highest rate CD, which means your money can be tied up for a long time, perhaps as long as 5 years.

A CD ladder, however, allows you to spread out the maturity dates for the CDs, which means you’ll have sooner availability of your money and are generally more nimble. You’ll also be able to take advantage of higher interest rates with at least part of your savings if interest rates are rising.

Also by using a ladder, it’s less likely you’ll need to break a single large CD due to a cash emergency. If needed, you can access the funds in just one CD, leaving the others intact.

Expect to pay a penalty for breaking the CD ladder, often wiping out the earnings and possibly causing you to lose some of your principal. However, when you have an emergency, these are probably smaller considerations.

What is a CD laddering strategy?

There are several ways you can structure a CD ladder, with the type of ladder largely determined by your need to access the cash in your CDs. With CD maturity dates of up to 10 years available, it’s possible to build very long ladders.

However, most use cases for CD ladders are better served by a 5-year CD ladder or a shorter ladder of 1 or 2 years, also sometimes called a mini-CD ladder.

Another strategy that builds a hedge against rising interest rates is called a barbell CD ladder and splits deposits between a separate high-yield savings account and short term CDs to build a mini ladder. This last strategy allows faster access to money that can be used to buy higher rate CDs if interest rates rise.

5-year CD ladder

  • 1-year CD: $1,000
  • 2-year CD: $1,000
  • 3-year CD: $1,000
  • 4-year CD: $1,000
  • 5-year CD: $1,000

As the 1-year CD matures, it can be rolled over into a new 5-year CD, which probably pays a higher interest rate. Over time, using this process can help to boost your overall return from your CD ladder because you’re replacing lower interest CDs with higher interest CDs as you “climb the ladder”.

For many households, the idea of tying up money for a year can be unnerving. In this case, a mini-CD ladder may be a better strategy. Think of a 1-year or 2-year timeframe for the entire ladder to reach maturity. We looked at a simple mini-CD ladder earlier.

Mini-CD ladder

  • 3-month CD: $1,000
  • 6-month CD: $1,000
  • 9-month CD: $1,000
  • 12-month CD: $1,000

This ladder only has 4 steps, but it's also possible to build it with a CD reaching maturity monthly for more frequent access to money if needed. A barbell CD ladder puts half of the money in a high-yield savings account and the balance in a mini-CD like the one above.

Assuming you have the same amount CDs and in a savings account the two parts resemble a barbell, with the same amount of weight (money) on each side.

If CD rates increase above the rate you’re earning on the savings account, the money in savings can be used to buy higher rate CDs for the ladder.

This strategy places its focus on building flexibility so you can take advantage of rising interest rates by putting a larger amount of money to work. The CD strategy you choose needs to consider your cash flow needs.

If you have enough money saved for short-term household emergencies, a 5-year ladder can be a fit, paying higher interest rates in exchange for longer deposit requirements. However, if cash availability is a concern or could be in the future, a mini-CD may be a better choice.

Of course, if you choose a mini-CD ladder and find you don’t need the money as the CDs mature, its possible to shift strategies and use maturing CDs to build a longer CD ladder, like a 5-year ladder.

How to build a CD ladder?

Building a CD ladder isn’t usually a complicated process, but some ladders can seem more complex than others. The first thing to consider is whether you may need access to some of the money on short notice. If this is the case, then starting with a mini-CD ladder may be the best option.

Short-term CD ladder

For example, let’s say you have $4,000 available as a result of saving or from a windfall, like an unexpected tax refund or a bonus at work.

Many banks have a minimum deposit required to open a CD, so you may need a bulk amount of money to get started. While you can find banks that have a lower minimum — or none at all, $1,000 is a fairly common minimum CD deposit.

CD yields vary and banks often run promotions, so it’s also possible that your CDs might be held with different banks to maximize the rates for each CD term.

To build a 1-year mini-CD ladder, you can purchase 4 CDs:

  • 3-month CD of $1,000 at 0.5% APY
  • 6-month CD of $1,000 at 1.0% APY
  • 9-month CD of $1,000 at 1.5% APY
  • 12-month CD of $1,000 at 2.0% APY

An APY is an annual percentage yield and provides an easy and standardized way to compare rates even for CDs with shorter time to maturity.

Your actual APY may be higher or lower than in this example, but it’s common for longer-term CDs to have a higher APY, so you can expect rates to be higher for a 12-month CD than for a 3-month CD.

In 3 months, the first CD will reach maturity and can be withdrawn without penalty. However, if you don’t need the money, you can use the funds to purchase another 12-month CD, which brings your ladder back to 4 CDs.

The 6-month CD now only has 3 months left to maturity, with 3 other CDs behind it reaching maturity at 3-month intervals. In this example, the interest earned on the first 3 month CD at 0.5% is $1.25, which won’t buy much these days.

However, if you roll it over into a 12-month CD, compound interest can begin to do its magic. Your newly purchased 12-month CD will pay 2.0% on a balance of $1001.25, including the interest you rolled over as well.

With smaller balances and with the lower yields often found on short-term CDs, the returns can be underwhelming at first but as you continue the process, the balances will grow because you’re rolling over the short-term CDs to longer-term CDs with a higher yield and earning interest on your interest as well as the original principal.

The balance you rolled over from the mature CD ($1,001.25) will earn $20.23 over the next year in the new 12-month CD with a 2.0% APY. The process works similarly for the other CDs you initially purchased, the 6-month, 9-month, and the original 12-month CD.

The difference is that each is earning a higher rate and will produce even more interest that can then be rolled over with the balance at maturity.

Long-term CD ladder

If you want to convert your short-term CD ladder to a longer ladder, like 5 years, this can be done over time by purchasing longer-term CDs as your short-term CDs mature. 5-year ladders are the most common type of CD ladder and require 5 separate CDs maturing at 1-year intervals.

Typically, a new 5-year ladder is built using equal amounts in each CD, but there aren’t really any rules — except those imposed by the bank in regard to minimum deposit requirements.

It’s even possible to have long-term ladders and short-term ladders at the same time. It’s your money, so feel free to arrange your ladders as you see fit.

Short-term ladders offer more frequent availability of funds and an easy way to capitalize on rising interest rates. Long-term ladders provide a hedge against falling interest rates but at the expense of immediate liquidity.

When building a CD ladder, be sure to communicate with your issuer if you want to use a maturing CD to buy a CD of a different term.

Otherwise, your bank may rollover the CD or renew the CD automatically for the original term and at the current interest rate. You’ll receive notice from your issuer when your CD is about to mature.

CD ladders vs. other investments

The average annual return for the S&P index since its inception is about 10%. Interest rates can change quickly, but the highest rates for 5-year CDs are currently under 4%, with most under 3%.

Stock market

While the return from a stock market index fund or index ETF can look like a tempting alternative to CD ladders, the average historical S&P returns don’t properly illustrate the risk.

During the financial crisis in 2008, broad market investors lost as much as 7% in a single day. Over the course of a 17-month bear market beginning in 2007, the S&P index lost over half its value.

That won’t happen with CD ladders. Your principal is protected. Other alternatives, like money market accounts or high-interest savings accounts, offer more safety than the gyrations of the stock market, particularly with a shorter time horizon in mind.

High-yield savings accounts

High-yield savings accounts can be attractive as well. Typically, you can expect rates in line with a 12-month CD, although rates for both high-yield accounts and CDs can vary widely.

There are a few considerations to evaluate, however. High-yield savings accounts are variable rate accounts. This means the interest rate can go up or down. CDs are usually fixed rate, which eliminates much of the downside risk.

You’ll also find that most high-yield savings accounts are available through online banks. You probably won’t be able to go to your local branch and withdraw funds as needed.

There may also be minimum initial deposit requirements or minimum balance requirements for high-yield savings accounts.

Money market accounts (MMA)

Money market accounts can also pay rates similar to CDs and can provide easier access to your savings, although you’re likely to find minimum balance requirements that limit availability.

Easy access to your funds may not be desirable, though, particularly if you have an important savings goal in mind.

CDs effectively lock away your money while it earns interest and the penalties for early withdrawal force savers to think twice before spending savings on a whim.

One option isn’t necessarily better than another, but a CD ladder may be a better fit for your long term goal than some of the other options if you want to build long-term savings without risk.

What types of CDs can you use in a ladder?

While standard CDs are the most commonly available, there are several other types of CDs you can use to build a CD ladder.

  • Callable CD: A callable CD can often offer higher interest rates, but there’s a catch, and it’s in the name. The issuer can recall the CD after a set amount of time, like 6 months for example. You’ll get your principal and the interest due to date, but you’ll have to find another CD or savings vehicle if the CD is recalled, possibly breaking the structure of your CD ladder. Callable CDs tend to have longer maturity dates. Issuers are more likely to recall a CD if interest rates are falling and the issuer can borrow for less than the rate they’re paying on your CD.
  • Jumbo CD: In most cases, jumbo CDs begin with amounts of $100,000. In exchange for committing a larger amount of money, jumbo CDs tend to pay higher rates, even for short-term CDs. Like regular CDs, the rate is usually higher for longer terms.
  • No-penalty CD: One of the biggest risks with CDs is that you might need access to the money before the maturity date. No-penalty CDs answer this concern by eliminating the early withdrawal penalty. This type of CD is extremely rare, at least in a pure form. Some CD issuers advertise using similar names but may limit withdrawals without penalty to certain circumstances, like the loss of a job.
  • Bump-rate CD: Another risk to owning CDs is that interest rates can rise while you have your money tied up in a fixed-rate CD at a lower rate. Bump-rate CDs, also called step-up CDs, allow you to “bump up” your interest rate on the CD. Expect some limitations on how many times your CD interest rate can be bumped up, especially for shorter-term CDs, which may be limited to only once.

Tax implications for a CD ladder and are the funds insured?

As with many financial products, there’s good news and there’s not-so-good news. The good news is that CDs are considered to be deposit accounts and CDs purchased through banks are insured by the Federal Deposit Insurance Corporation (FDIC).

For insurance purposes, CDs would be grouped with other accounts of the same category, like savings accounts and checking accounts, for a combined insured total.

Current FDIC limits are $250,000 per person per account category at a given bank.

CDs purchased through federal credit unions have similar coverage but coverage is provided by the National Credit Union Administration (NCUA).

CD interest earnings are taxed

The not-so-good news is that you’ll have to pay taxes on your CD interest earnings in many cases. The principal you used to purchase the CD is not taxable but if the amount you withdraw or roll over when the CD matures exceeds the principal, expect the difference to be taxable in most cases.

For longer-term CDs, federal tax laws prevent tax-deferred interest for more than a year, so you’ll be responsible for taxes on the interest you’ve accrued but haven’t yet collected because it’s in the CD balance.

To put this in perspective, however, the same rules apply to other types of interest-bearing account and the out-of-pocket cost to many households is manageable at tax time.

CD ladders for your retirement account

CDs and CD ladders can also be used in retirement accounts, which can change how taxes are applied. Interest income from CD ladders built within an individual retirement account (IRA) may or may not be taxable, depending on the type of IRA.

Roth IRAs are generally not taxable and traditional IRAs offer tax-deferred earnings. With both types of IRAs, if you withdraw money from the IRA prior to eligibility, the tax treatment can change.

Should you use CD ladders?

CD ladders are often used by people approaching retirement when investment risk is a bigger concern and capital preservation is a bigger priority but the benefits of using a CD ladder are age-agnostic.

A CD ladder can be used as a savings vehicle for a future purchase or as a long-term emergency fund. You’re also not limited to the number of CDs in your ladder.

While smaller ladders are easier to understand and manage, many people have CD ladders that hold 12 CDs maturing at 1-month intervals, planning for a full year of income if needed.

Others mix long and short-term ladders with each ladder serving a different savings goal.Cast a wide net when shopping for CDs. Rates may be better from online banks that have lower overhead.

However, always be sure to read the fine print. The rules or limitations for each CD or issuer can affect your bottom line.

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