What Is a CD Ladder? 

Katie Wood is a senior investment consultant at Northwestern Mutual.

Investing can be a powerful way to build wealth over the long term, but it doesn’t come without risk. Even low-risk investments are not risk free—you still could end up losing your initial investment or experience periodic volatility. That’s why it’s generally not a good idea to invest money that you need in the short term (one to five years) in the market.

A savings account, on the other hand, typically won’t earn much interest, depending on the interest rate environment. So between your emergency fund and other short-term savings, you may have quite a bit of cash sitting on the sidelines when it could be earning you more money. There are still low-risk ways for you to put your money to work to earn a return while still preserving access to your money. One option is to build a CD ladder.

Let’s take a look at what a CD ladder is and how it works. We’ll also discuss the different reasons people tend to use CD ladders and the pros and cons of this approach.

What is a CD ladder?

CD laddering is an investing strategy that involves purchasing multiple certificates of deposit (CDs), each with a different term (length of time you’ll leave money in the CD) or maturity (time at which you can take money out of the CD)—some short and some long. When the CD with the shortest term matures, you can then decide to either take the money out and spend it or roll it over into a new CD.

The goal of a CD ladder is to preserve regular access to your money while also earning a return in the form of interest payments. This is why it’s so important that the CDs carry staggered maturity dates.

How long should a CD ladder be?

You can build a CD ladder that is months long, a year long or multiple years in length. And you can continue rolling the CDs over into new CDs for as long as this strategy still works for you. You’ll have access to the money you need as soon as you reach the next rung on your ladder. Your laddering strategy will depend entirely on your personal situation and what you’re trying to achieve.

Can you withdraw money from a CD ladder early?

Yes, you can withdraw money from your CD ladder early just like you would be able to if you had a single CD. But to do so, you may need to pay an early withdrawal fee, which is typically a forfeit of interest accrued. In some cases, you could even lose some of your principle—depending on the terms of your CD.

Do you pay taxes on CD interest?

Yes. The interest you earn from your CD ladder is taxed as ordinary income and included in your taxable income on your tax return.

Why do people build CD ladders?

The point of building a CD ladder is to put your money to work in a low-risk way so that it can earn more interest than a savings account while also staying somewhat accessible. With this in mind, CD ladders are commonly used for things like:

• Emergency funds, which you may need to access in the short-term to cover unexpected expenses.

• Short-term savings, such as the down payment on a home or car, that you plan to access within one to five years.

• Cash cushions during retirement, which can help you ride out market volatility.

A particularly risk-averse investor might even use a CD ladder as a means of generating income out of a portfolio without having to sell assets, though other options—like bonds, dividend stocks and mutual funds—can earn more in the long run.

CD ladder examples

You can build CD ladders in many different ways, depending on how accessible you want your funds to be. Below are a few examples of the most common types of CD ladders.

Traditional CD ladder

In a traditional setup, you would take your money and divide it evenly among multiple CDs with staggered terms. The duration of your ladder and how much you dedicate to each CD would depend on your personal goals.

For example, let’s imagine that you had $5,000 to invest and that the longest period of time you wanted your money deposited was five years. In this scenario, you may want to consider setting up a ladder that would probably look something like this:

• $1,000 in a 5-year CD

• $1,000 in a 4-year CD

• $1,000 in a 3-year CD

• $1,000 in a 2-year CD

• $1,000 in a 1-year CD

When the one-year CD matures, you could then decide to either hold onto the funds and the interest you’ve earned or reinvest them in a five-year CD to keep the ladder going. Or you could then put that money to work another way—it’s up to you.

Mini CD ladder

Mini ladders can be useful for very short-term savings or, potentially, for an emergency fund. They can also be helpful if you are unsure about where interest rates are going in the long term.

A mini CD ladder works the same way as a traditional ladder but consists of shorter terms—often with the longest term being one year. For example, let’s imagine that you have built an emergency fund that holds $40,000. To make sure you’ll have opportunities to access this money if you need it, you might choose to invest your money like this:

• $10,000 in a 12-month CD

• $10,000 in a 9-month CD

• $10,000 in a 6-month CD

• $10,000 in a 3-month CD

This way, if you ever need to access your emergency savings, you know that every three months you will free up enough money to cover you for an additional three months. And if you don’t need to access the money to cover an emergency, you’d simply roll the matured CD over into a new short-term CD.

Uneven splits

In both examples above, you split your money evenly among all of the CDs in your ladder. But that’s not a requirement. You could also put different amounts into each of the CDs in your ladder. This strategy is often used when interest rates are in a period of flux or when there is significant uncertainty over where rates may be headed. In a rising rate environment, for example, you might be inclined to put more of your money into short-term CDs and less of it into longer-term CDs. And in a falling rate environment you might do the opposite—placing the bulk of your money in longer-term CDs and less in short-term CDs.

If you had $10,000 to invest during a rising rate environment, for example, you might build a ladder that looks something like this:

• $4,000 in a 1-year CD

• $3,000 in a 2-year CD

• $2,000 in a 3-year CD

• $1,000 in a 4-year CD

Properly designing an unevenly split CD ladder takes a certain level of financial understanding and comfort with forecasting interest rates. A financial advisor can be a great resource for information and advice as you plan.

Pros and cons of CD ladders

CD ladders offer a number of potential benefits that you might want to take advantage of, but they have drawbacks, too. Here’s a quick look at the pros and cons of incorporating a CD ladder into your broader financial plan.

Pros of CD ladders

They are relatively low risk

CDs, like checking and savings accounts, are FDIC insured up to $250,000 per depositor, per institution. This means that there is a relatively low risk that you will lose your principal, even in the event that the bank goes out of business.

They offer guaranteed returns

CDs offer guaranteed returns, unaffected by the performance of the stock market or broader economy. Once you’ve opened a CD, you can rest easy knowing that your interest rate is locked in, even if interest rates move lower in the future.

They provide flexibility and liquidity

A CD ladder provides more flexibility and liquidity than putting all of your money into a single long-term CD would. This flexibility makes it easier to take advantage of changing interest rates and allows you to reinvest your funds elsewhere if your investment goals or strategy changes over time.

Cons of CD ladders

Lower returns

How much interest your CDs yield will depend on a number of factors, including their terms, how much you invest in them and underlying economic conditions. But generally, over time they often yield lower returns than riskier investments like stocks and bonds.

They’re not entirely risk-free

While CDs carry a low risk of principal loss, that does not mean they are completely risk free. Other investment risks, such as inflation risk, interest rate risk and reinvestment risk, could still come into play.

They’re not completely liquid

CD ladders offer more liquidity than other options, but they are not fully liquid. If you find yourself needing to access the money held in a CD before it matures, you could be on the hook for fees. Options like a high-yield savings account might offer greater liquidity and may even offer comparable interest rates.

Is CD laddering a good idea?

Incorporating a CD ladder into your financial plan can allow you to grow some of your larger sources of cash while also preserving flexibility to access funds when you need them. But that doesn’t necessarily mean that this strategy makes sense for everyone.

As with any investing strategy, it’s important to not look at any one investment in isolation. You’ll want to keep the big picture in view, understanding how this investment might work with other financial tools you’re using.

A Northwestern Mutual financial advisor can help you look at what you’ve got in motion and what you might want to add. By getting to know you and what you’re hoping to achieve, your advisor can help you design a tailored strategy that aligns your priorities with your financial options—ultimately giving you a financial road map for where you want to go.