3 Reasons to Use a 5-Year CD As You Approach Retirement

Do you have a long-term savings goal as you approach retirement? You may want to save for a down payment on a house as you plan to downsize or upsize, or maybe you're saving for a big vacation with family or friends.

If you have a goal in mind, finding the right savings solution can help you stay on track to achieve it. This is where the best five-year CD rates can be useful. A five-year CD is a fixed savings option that requires you to deposit your money and leave it for the entire term. It also offers fixed interest rates, so you don't have to worry about decreasing returns if the Federal Reserve cuts rates.

There are pros and cons to using these tools, which I'll get into. Then, I'll discuss three smart reasons to use one and one costly mistake to avoid.

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Why I like five-year CDs

Here are a few reasons why I like five-year CDs:

They offer guaranteed returns
APYs currently outpace inflation
Many come with FDIC insurance, protecting your assets up to $250,000 per member

If you're ready to secure your financial future for the next five years, don't wait for rates to drop. Compare the best five-year CD rates using the tool below to lock in a guaranteed return and start working toward your long-term goals:

Things to consider before opening one

On the other side of the coin, here are a few things to keep in mind before signing up for a five-year CD:

You could earn higher returns with index funds and other investment vehicles, historically
Early termination penalties are high, equating to a year of earned interest
Inflation can eat away at your future earnings

If you're OK with the risks, here are three smart reasons to use a five-year CD:

1. Saving on a down payment for a home

As you approach retirement, you might consider changing your address. You could be following a trend where you want to upsize in retirement to accommodate family gatherings or downsize to reduce maintenance.

In any case, a five-year CD can help you stay on track toward your goal. The reason is that they require discipline – if you cash it out before maturity, it can lead to serious financial consequences, such as losing hundreds or thousands of dollars in early withdrawal fees.

As such, earmarking money you know you won't touch can give you confidence that you'll reach that goal in time to buy your home. Use our mortgage calculator to determine how much you'll need to put down to make your mortgage payment budget-friendly.

2. Reallocating money as you near retirement

Another reason to consider a five-year CD is if you're approaching retirement and are looking for less risk for a portion of your investments. A five-year CD fits the bill well because you won't have to worry about market volatility.

You can devote a portion of your money to guaranteed growth. Say you place $100,000 in a five-year CD with SchoolsFirst Federal Credit Union, at a current APY of 4.00%. After five years, you would earn $21,665.29.

To be fair, you won't earn rates nearly as high as you would with an index fund tied to the S&P 500 or other investments, based on historic performance. Yet, you also won't have to worry about loss and volatility either.

You can park the money for five years, earn a significant return, then reinvest it as your financial needs evolve. It can also achieve balance for your portfolio, especially if it contains a lion's share of higher-risk investments.

3. Starting a business

A restaurant business owner talks with an employee behind the bar.

As you approach the finish line of your career, your retirement gives you the financial freedom to explore side gigs or to start your own business. Doing this keeps you active, earns you more income and helps you socialize.

If you already have an idea of what you want to start, then saving for it now ensures you're prepared to hit the ground running when you retire. A five-year CD can be a smart way to save for future business expenses, as you can predict how much you'll need at the time of funding.

Most importantly, you won't have to rely on as much credit. Using the five-year CD example above, if you plan to start a business in retirement, you could have an extra $20,000 or more by the time you retire. This can give you seed money to buy supplies, advertise, set up an LLC and other expenses that might arise.

While these are suitable options for tucking your cash away for five years, there is a situation when using a five-year CD won't be beneficial.

Avoid this five-year CD mistake

You should not put the entirety of your cash savings in a five-year CD, especially if you'll retire before the five-year term is up. This is also true even if you have other savings, but they're tied up in the market.

While you need to have appropriate savings for your retirement, you also need an appropriate amount of those savings to be immediately accessible to pay bills in your post-salaried life. Five-year CDs feature steep early withdrawal penalties, which could do more harm than good if you need regular cash access and don't have other savings available.

The only time this would potentially work is if you're using a five-year CD as part of a laddering strategy with short-term CDs. Then, you'll have regular access to income.

How it works is that you open a series of CDs, staggering their maturity dates to give you cash access. An example of this, using a $100,000 deposit, would be:

$20,000 to a six-month CD
$20,000 into a one-year CD
$10,000 into a three-year CD
$25,000 into a five-year CD
$25,000 into a no-penalty CD (that allows withdrawals after a week)

An alternative savings consideration with less maintenance is to allocate some funds into a high-yield savings account. It will be a better short-term solution because you'll have access to cash as needed, and you won't have to manage five CDs.

With rates as high as 4.35% APY with minimal fees, a high-yield savings account is a great way to stay ahead of inflation and reach savings goals.

Use this Bankrate tool to find the best high-yield savings account options for your needs:

Five-year CDs can help you reach your goals

Approaching retirement opens the door to other opportunities. Whether you want to move, start a business or allocate money to less risky investments, you can have peace of mind knowing a five-year CD can help you reach your goals.

Sean is a veteran personal finance writer, with over 10 years of experience. He's written finance guides on insurance, savings, travel and more for CNET, Bankrate and GOBankingRates.