A certificate of deposit (CD) account is a savings account that holds a fixed amount of money for a fixed period, typically at a higher interest rate than regular savings accounts. The issuing bank or credit union pays interest on the deposit until the CD reaches its maturity date.
If you hold your CD until maturity, you’re guaranteed your initial investment plus interest. But if you withdraw before the term ends, a penalty usually applies. CDs are ideal if you want to securely save a lump sum and don’t require immediate access to those funds.
Key Takeaways
CDs typically offer higher interest rates compared to regular savings accounts.
CDs provide a safe way to earn a guaranteed return compared to other investments.
While there are different types of CDs, they usually have fixed terms, meaning you agree to leave your money for a set period.
Understanding CD Accounts
A certificate of deposit (CD) is a contract between you and a bank where you deposit a sum of money for a fixed term, as short as three months or as long as five to ten years in some cases. CD accounts require you to leave your money untouched until the withdrawal date to earn interest. The bank pays you interest on this amount. CD accounts are generally available through banks and credit unions.
How CD Accounts Work
A CD account requires you to specify the term and then make an initial deposit. The interest rate available to you will depend on the length of the term and the amount you deposit — generally, higher deposits will yield higher interest rate opportunities.
Some key features of a CD account include:
Interest Rate
This is the rate at which your money grows, fixed for the term. The interest rate for a CD is typically higher than a traditional savings account.
Term
The term is the period of time you agree to leave your money in the account.
Opening Deposit
This is the initial amount you need to put down to open the CD.
Early Withdrawal Penalty
You typically pay a penalty if you withdraw funds before the CD matures.
ARE CD ACCOUNTS FDIC-INSURED?
CDs offered by banks are FDIC insured up to $250,000 per depositor. NCUA insurance provides similar protection for CDs offered by credit unions.
How CD Rates Are Determined
CD rates are mainly influenced by the Federal Reserve's federal funds rate, which sets a benchmark for interest rates in response to the broader economic environment. The actual CD rates offered to you will vary based on the financial institution, term length, CD type and deposit amount.
HOW TO MAXIMIZE CD RATES
To maximize your CD rate, shop around, look for promotional rates, avoid early withdrawals and deposit as much as you can.
What Are the Types of CDs?
There are a variety of CD (certificate of deposit) types available to you, depending on your needs and your investment goals. Banks and credit unions aren’t required to offer every kind, so it’s helpful to understand what you want out of your investment before you start — and to shop around at different banks — to find the right product mixture for you.
CD Type | Description |
|---|---|
Traditional CD | Fixed interest rate and term length |
High-Yield CD | Offers a higher interest rate than traditional CDs |
Bump-Up CD | Allows you to increase the interest rate once during the term |
Step-Up CD | Interest rate increases at regular intervals |
Liquid or No-Penalty CD | Allows early withdrawal without penalty |
Jumbo CD | Designed for very high deposit amounts |
IRA CD | Held within an Individual Retirement Account (IRA) for retirement savings |
Brokered CD | Sold through brokerage firms and often offer higher interest rates, though they can come with additional risks and fees |
Pros and Cons of CD Accounts
Overall, CD (certificate of deposit) accounts are insured investment tools that offer access to higher interest rates than traditional savings accounts. But you lose access to your money until the CD matures, which requires diligence and tight financial planning.
We highlight more of the benefits and drawbacks of CDs below.
Pros of CD Accounts
Higher Interest Rates
CDs typically offer better interest rates than regular savings accounts.
Safety
CDs are FDIC-insured up to $250,000 per depositor and NCUA-insured for credit unions.
Predictable Returns
The fixed interest rates of CDs provide a guaranteed return.
Diverse Options
The different types of CDs available can meet varying financial needs.
Cons of CD Accounts
Limited Liquidity
CD funds are locked up for the term length, with penalties for early withdrawal.
Inflation Risk
The fixed interest rates of CDs may not keep up with inflation, diminishing your final returns.
Opportunity Cost
The money tied up in a CD can't be invested elsewhere if better opportunities arise.
HOW ARE CDS TAXED?
The interest earned on CDs is taxed as ordinary income at your individual federal income tax rate, which can range from 10% to 37%, depending on your taxable income and filing status. In addition to federal income taxes, you may also be subject to state and local taxes on your CD interest, depending on where you live.
CD Accounts vs. Other Savings Accounts
When choosing where to place your savings, compare CDs and savings accounts to see which best suits your needs. The best for you will depend on how you want to use the money and how long you feel comfortable leaving it untouched.
High-Yield Savings Account vs. CD Account
Both high-yield savings accounts and certificates of deposit are interest-earning accounts, but they work differently. A high-yield savings account offers a higher interest rate than traditional savings accounts.
High-yield savings accounts offer greater liquidity, but their interest rates are variable. This means the rate can fluctuate at any time, depending on market conditions.
CDs have fixed interest rates that are locked in for a set term. This provides certainty about your earnings but also means that you can't access your money without penalty until the term ends. You also can’t invest the funds elsewhere if better opportunities arise without losing money.
Feature | High-Yield Savings | CDs |
|---|---|---|
Initial Deposit | Low or no minimum | Minimum deposit required |
Interest Rate | Variable | Fixed |
Withdrawal | Easily accessible | Restricted until maturity |
Penalties and Fees | Limited penalties, if any apply | Early withdrawal penalties may apply |
Insurance | FDIC insured up to $250,000 | FDIC insured up to $250,000 |
CAN YOU ADD MONEY TO A CD?
Typically, you can’t add money to a CD after you’ve made your initial deposit. At maturity, you’ll have a grace period to add or withdraw funds.
There is an exception for add-on CDs. Add-on CDs are a special type of CD that allows you to add money to your initial balance by making an additional deposit during your CD’s term. Add-on CDs aren’t as common as regular CDs; not all banks and credit unions offer them.
Money Market Account vs. CD Account
Both CDs and money market accounts (MMAs) usually offer higher interest rates than traditional savings accounts. MMAs allow up to six transactions per year and have variable rates, whereas CDs require you to wait for the term to mature before accessing your deposit to avoid penalties.
Feature | MMAs | CDs |
|---|---|---|
Initial Deposit | Typically higher than savings accounts | Minimum deposit required |
Interest Rate | Variable, tied to market interest rates | Fixed |
Withdrawal | Limited withdrawals per month, may have fees | Limited penalty-free withdrawals |
Penalties and Fees | May have fees for exceeding withdrawal limits | Early withdrawal penalties may apply |
Insurance | FDIC insured up to $250,000 | FDIC insured up to $250,000 |
How to Open a CD Account
A CD account can be a smart financial move, especially if you have a sum of money you don’t anticipate needing soon. If you expect a drop in interest rates, locking in a good rate with a CD now can be an excellent strategy to secure your return on investment.
Opening a CD account takes just a few simple steps:
1
Research
Compare rates, terms and the different kinds of CDs available from different banks and credit unions.
2
Choose a CD
Select the CD type and term that best fits your financial goals.
3
Apply
Complete the application process online or at a local branch.
4
Fund the CD
Deposit the required amount to open the CD.
HOW TO AVOID SCAMS WHEN CHOOSING A CD
When choosing a certificate of deposit, avoid scams by taking the following actions:
- Confirm the Institution: Ensure it’s an FDIC-insured bank or NCUA-insured credit union. Don’t open a CD if you can’t guarantee the funds will be insured in case of a bank failure.
- Be Wary of Third-Party Brokers: They may mislead or scam you. When possible, work directly with your institution of choice or a preferred broker they trust.
- Understand Interest Payments: Some CDs have variable rates or accrue interest only at maturity, so make sure you understand how your funds will earn you money.
FAQ About CD Accounts
We answered some of your commonly asked questions about CD (certificate of deposit) accounts.
What happens if you withdraw early from a CD account?
If you withdraw money from a CD before it matures, you’ll typically have to pay an early withdrawal penalty. The penalty is usually a certain number of months’ worth of interest. The exact amount depends on the terms of the CD and the bank.
How much money do you need to start a CD account?
The minimum deposit required to open a CD account varies by bank. Some banks require as little as $0, while others may require anywhere from $500 to $10,000 or more.
Are CD rates going up or down?
While CD rates have fluctuated over the past year, they have started to flatten out as of 2024. Market conditions can change quickly, so it's best to check current interest rates directly with banks or credit unions.
What is a CD ladder?
A CD ladder is a savings strategy where you invest in several CDs with staggered maturities. This strategy involves opening multiple CDs with different maturity dates, which can potentially provide better flexibility and maximize your returns.
What are the requirements for a CD account?
To open a CD account, you typically need to provide personal information such as your name, address and Social Security number. You may also need to provide identification, such as a driver's license or passport. The minimum deposit requirement varies by bank.
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About Alvin Yam, CFP
Alvin Yam is a certified financial planner with over 15 years of experience working with individuals and corporations. He is an expert in wealth management and personal banking. Alvin is also the Founder and Managing Partner at Paraiba Wealth Management, an independent registered investment advisor.
Prior to founding Paraiba, Alvin spent five years as a Director at HSBC overseeing retail and wealth products, and was also a Financial Consultant at Charles Schwab, advising clients on investments, retirement planning and banking products.
sources
- FDIC. "Shopping for a Certificate of Deposit?." Accessed June 21, 2024.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
Editorial Disclosure: Opinions, reviews, analyses and recommendations are the author’s alone and have not been reviewed, endorsed or approved by any bank, lender or other entity. Learn more aboutour editorial policies and expert editorial team.
