Should You Use Your Tax Refund to Open a CD?

At this point, many people have filed their taxes and are waiting for their refunds to hit their bank accounts. If you're anticipating a nice payday from the IRS in the coming weeks, you may be thinking about opening a certificate of deposit (CD). But is that a good idea? It could be -- under the right circumstances.

Why now's a good time to open a CD

The Federal Reserve spent a good chunk of 2022 and 2023 raising interest rates to slow the pace of inflation. As such, savings account and CD rates are up right now.

But at some point in 2024, the Fed is likely to start cutting rates as long as inflation doesn't jump. And once that happens, CDs may start to pay a lot less. If you're getting money back from the IRS later this month or in April, it could pay to use it to open a CD and lock in a higher rate on your cash while you can.

When you shouldn't open a CD

Although it's a good time to open a CD in general, and a tax refund is a great way to fund one, there are a couple of scenarios where it's not the best idea to use that cash for a CD. The first is if you have no emergency fund, or you have a really small one that won't suffice in covering at least three full months of essential living expenses.

In late 2023, SecureSave found that 63% of Americans could not cover an unplanned $500 expense by dipping into their savings. So if you're in a similar situation, do not put your tax refund into a CD, where you'll risk a penalty for withdrawing your money before your CD matures. In that case, your money belongs in a savings account.

A second scenario where a CD doesn't make sense right now is if you're carrying high-interest debt. Let's say you're getting a $2,000 tax refund, only you owe $2,000 on a credit card with an 18% APY. You may be able to get, say, a 5% APY on a 1-year CD. But you'll lose more money in interest on your credit card in this case than you'll gain by keeping that cash in a CD for the next 12 months.

Think through your options carefully

It can be tempting to open a CD at a time when rates are attractive, and when there's also talk of rates shrinking in the not-so-distant future. But before you open a CD, think about your other financial needs.

If you need to boost your emergency fund or pay off costly debt, hold off on getting a CD. And even if you have solid emergency savings and no high-interest debt, before you commit to a CD, think about your broad financial picture.

Is your laptop showing signs of wear? If so, you might need to replace it. Has your car been making interesting sounds on the way to work? You may soon be looking at a repair, in which case having your money tied up in a CD may end up being a point of stress.

In some cases, opening a CD with your tax refund is a really savvy move. But make sure you can afford to tie that money up before you actually do it.