CD Ladder: How to Make One, Benefits, FAQ

What Is a CD Ladder?

When you create a CD ladder, you divide the total amount of money you want to invest into equal amounts and invest those amounts in certificates of deposit (CDs) with different maturity dates. After one CD matures, you reinvest that CD's money into a new, longer-term CD.

This approach ensures that if you need the money from a CD, you have predictable access without paying a penalty. It may be helpful to think of this strategy as more like a slow-moving revolving door than a ladder.

How to Build a CD Ladder

A CD is an investment product offering a fixed interest rate for a specified period of time. The invested funds, which are insured up to $250,000 by the Federal Deposit Insurance Corp. (FDIC), are locked in by the issuing bank until the maturity date of the CD.

Investors can follow the CD ladder strategy to take advantage of the various interest rates offered for different time periods and maintain predictable access to funds,

Let’s say you have $20,000 to invest and want to build a four-year CD ladder.

Step 1: Open Separate CDs

Maturity dates for CDs are typically set at lengths such as 3 months, 6 months, 1 year, or 5 years. Rather than putting the entire $20,000 in one 5-year CD, you put $5,000 in each of four CDs. One will mature in 1 year, then another at 2 years, the third in 3 years, and the last in 4 years. Seek out the banks with the best rates on CDs before investing the funds. What you start with is:

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

Step 2: Renew and Convert Each CD at Maturity

As each CD matures, you renew it as a 4-year CD. By doing so, after 4 years you would've had four 4-year CDs, but only one will mature annually.

If you had opened all of your CDs in January 2023, setting up the ladder would look like this:

• January 2024: renew the maturing 1-year CD into a new 4-year CD
• January 2025: renew the maturing 2-year CD into a new 4-year CD
• January 2026: renew the maturing 3-year CD into a new 4-year CD
• January 2027: renew the maturing 4-year CD into a new 4-year CD

This would allow you to leverage the higher interest rates on the longer-term CDs while building the ladder. You'd also be able to withdraw 25% ($5,000) of the overall ladder's funds annually without penalty, since one of the CDs would mature every year.

Mini CD Ladders

A mini CD ladder is the same concept as a regular CD ladder but with shorter-term CDs. You could build a mini CD ladder out of 3-month, 6-month, 9-month, and 1-year CDs to deploy the same strategy.

Keep in mind, though, that by building a ladder with shorter-term CDs, the interest rates you’ll get could be lower. Typically, the higher the term for which funds are committed, the higher the interest paid, but not always—in a volatile rate environment, you may find comparable or higher short-term rates. Check your bank or credit union's rates to discover what's true at your institution.

Advantages and Disadvantages of a CD Ladder

Advantages Explained

Consistent cash flow: A CD ladder strategy gives you a steady flow of cash as the CDs mature at different times. When they mature, you will get the interest

Exposure to higher rates on longer-term CDs: By spreading the investment over CDs with varying maturities, you benefit from the higher interest rates of longer-term CDs. You can avoid repeatedly renewing a short-term CD that holds all your funds.

Lowers interest-rate risk: A CD ladder provides regular opportunities to reinvest cash as the CDs mature while reducing interest rate risk. After all, if you put all your funds in one 4-year CD, you may miss out on a rise in interest rates that could happen in the next few years while your funds are locked away.

So, you can take advantage of rising short-term interest rates by reinvesting proceeds from maturing CDs into newer CDs with higher interest rates. On the other hand, if interest rates fall, you still enjoy the benefits of the stable, high interest rates that your existing long-term CDs provide.

Lowers liquidity risk: A CD's FDIC insurance protects against losing up to $250,000 should a bank become insolvent. If you need your savings, the laddering strategy ensures that you consistently have a CD maturing, thereby reducing liquidity risk. You know exactly how much you'll get back at the term's end.

Higher rates than savings accounts: Most CDs (and CD ladders) don't have fees or other charges if you follow the institution's requirements around early withdrawal and usually earn more than a savings account.

Disadvantages Explained

Doesn't completely eliminate liquidity risk: Although your CDs will mature yearly, it still means waiting for that date. If you break your CD early, you'll pay a penalty. Typically, this is several months' interest, but longer CD terms can involve higher penalties, even if you're only a few months from the CD's maturity date.

Requires some active management: This strategy may be a better fit for a more active investor. You'll need to seek out a bank with high long-term rates if your institution doesn't offer those rates and keep a careful eye on your CDs as they mature. If you don't move funds into a new, longer-term CD by a specific date, the CD could roll over into the same term that just ended, depending on your institution. Some institutions may offer "auto-roll" options but will still require some management.

CDs don't get any special tax treatment: CD ladders provide no special tax treatment to save money on local, state, or federal taxes. If you are in a high tax bracket, the ladders could be challenging to justify compared to other investments, such as U.S. Treasury Series I savings bonds are exempt from state and local taxes.

Tax-exempt municipal bonds are another option, although munis may have additional risks. CD ladders could make more sense if you're in a low tax bracket. Speak with a tax professional to be certain about a tax ladder's pros and cons for your situation.

Longer terms don't always earn higher rates: While longer-term CDs typically offer higher interest rates, this isn't always so. Traditional CDs at 24 months or longer may have lower rates than shorter-term promotional CDs. A mini-ladder may be a better fit at some institutions or you may want to consider another CD type, such as a no-penalty or bump-up CD. If CD interest rates decline instead of increase, rolling your funds into a new CD may not offer the higher returns of other investments.

The Bottom Line

As with any other investment, whether a CD ladder is right for you depends on your financial goals. Generally speaking, CD ladders are great for people who want a safer investment and predictable cash flows, and have time to manage the CD ladder's rungs.

The safest course of action with CDs is to use an FDIC-insured bank and ensure your deposits are covered by insurance limits. CDs are easy to understand, access, and structure to meet your financial goals. On the other hand, that safety means the rates of return for CDs are generally low compared to other riskier investments.