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You’ve done the hard work and filed your tax return, and now you get to reap the reward. You’ve got a nice refund check headed your way. You just need to figure out the best place to put it. If you’re looking to save that money for the future, you have several options.
A certificate of deposit (CD) is one of them. But it might not be a good fit for everybody. Here’s how to decide if it’s the right choice for you this year.
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How does a CD work?
CDs are a type of savings account that many banks and credit unions offer. They tend to offer high annual percentage yields (APYs), sometimes even higher than what you can find with high-yield savings accounts. And they’re locked in for as long as you have the CD. But the tradeoff for these high rates is a lack of accessibility.
When you open a CD, you agree not to touch the money in the account for a certain amount of time, known as the CD term. This could be anywhere from a few months to several years, depending on the CD you choose. If you withdraw your money early, you’ll pay a penalty, usually equal to several months of lost interest.
Is a CD the right home for your tax refund?
Given the restrictions on CDs, it’s probably not a good choice for your refund if you hope to access that money in the next few months. You’re better off going with a high-yield savings account. These accounts don’t guarantee your APY, but they also enable you to access your cash freely whenever you need it.
That said, a CD might not be a bad choice for those who don’t need to use their refund anytime soon. CD rates are high right now with some offering as much as 5.00% APY. The average tax refund as of Feb. 16, 2024, is $3,207. If you invested that in a 1-year CD with a 5.00% APY, you’d have over $3,367 in 12 months. And you could potentially wind up with a lot more interest if you invest in a longer-term CD.
What type of CD is best for you?
Short-term CDs tend to have term lengths of less than 12 months while long-term CDs have terms of a year or more. Generally, longer-term CDs offer higher interest rates. But with the high inflation rates lately, we’re in an odd situation where short-term CDs offer the most competitive rates. If you only want to lock up your money for a little while, this is the way to go.
However, many believe interest rates on CDs are going to begin falling in 2024. When rates begin to fall, it’s often seen as a good time to invest in long-term CDs because you can lock in a high rate. This could potentially pay off in the long run, but you have to be comfortable leaving your money alone for an extended period.
What you do with your tax refund is ultimately your call, but it doesn’t hurt to crunch the numbers and see what a CD could offer you. If you don’t feel it’s a good fit, you can always fall back on a high-yield savings account.
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