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Dear Dr. Don,
Can I invest in a five-year CD and have the interest deferred until it matures, thus avoiding the tax burden for
five years until I earn less and am in a lower tax bracket?
-- Gerry Growing
Dear Gerry,
You can't defer the income taxes due on a CD's interest earnings if the CD is held in a taxable account. CDs held
within a traditional IRA account will have the interest deferred, as does an investment in a CD-type annuity.
For taxable accounts, U.S. savings bonds are the only real option for tax deferral. Series EE or Series
I U.S. savings bonds allow you to defer taxes until the bonds are either redeemed or mature.
The current yield on a Series EE savings bond is 1.4 percent. The current yield on a Series I savings
bond is zero percent plus an inflation adjustment. You have to own the bonds for at least a year, and there is a three-month
interest penalty if you cash the bonds in within five years.
The Series I bond, despite the zero-percent fixed yield, could still return 2 percent to 4 percent from the
inflation yield over your five-year investment horizon. The six-month yield from the inflation component is currently
4.84 percent.
A CD-type annuity can give you the tax deferral you're looking for with a five-year investment horizon.
The Bankrate feature, "The pros and cons of CD-type annuities," provides
more information about this product.
I would avoid this product if you aren't in your mid-50s or older because of the tax implications pointed
out in the article: "CD-type annuities are tax-deferred investments, but if you cash your five-year CD before age 59½, you'll
pay the IRS a 10 percent penalty on the gain."
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