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What are the different types of certificates of deposit (CDs)?
Key takeaways
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CDs are fixed-term deposit accounts that typically offer fixed interest rates and FDIC insurance to at least $250,000 per depositor, per ownership type, per insured bank, making them safe, predictable savings options
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Traditional CDs provide the highest predictability with fixed rates, while specialized CDs like Bump-Up, Liquid, and Brokered types offer flexibility or enhanced features
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Choose CDs based on your goals. A wide range of CDs are offered to meet specific needs
Certificates of deposit (CDs) have long been a popular money management tool. Over the years, banks have developed many types of CDs to serve the varied needs of consumers.
A CD is a type of financial account that is designed to hold a fixed amount of money for a fixed amount of time, called the term. In return, the financial institution that issues your CD pays you interest. The interest rate is generally fixed, even if market rates go down, and the term can range from a few months to several years.
The structure of CDs is straightforward. In general, you make an initial deposit and leave the money untouched. It will then earn interest at a predetermined rate throughout the term. When your CD reaches maturity, you typically receive your principal plus the compounded interest. CDs may come with early withdrawal penalties, which serve as a deterrent to accessing your funds before the agreed-upon maturity date.
Understanding the various types of CDs can help you make the right choice for your financial situation.
What are the different types of CDs?
The financial industry offers many types of CDs to meet different savings needs and preferences. When people think of CDs, they might focus on the well-known, traditional CD. There are many other possibilities to consider, so let's review some popular options.
Traditional CD
Traditional CDs, the most common and accessible type of CD, offer complete predictability. You know exactly how much interest you'll earn over the term because the annual percentage yield (APY) remains constant. Traditional CDs come in various term lengths, typically from 3 months to 5 years or more. Generally, longer terms offer higher interest rates, rewarding customers for their extended commitment.
The primary advantage of a Traditional CD is its simplicity and reliability. You deposit the bank's minimum requirement, or more, wait for the term to end, and receive your principal plus the predetermined interest. An early withdrawal typically results in penalties.
Jumbo CD
A Jumbo CD requires a larger deposit than a Traditional CD. The typical minimum deposit is $100,000, but it could be lower. These CDs may offer better interest rates than standard CDs.
One important consideration with Jumbo CDs is that deposited funds are protected of to at least $250,000 per depositor, per FDIC-insured bank, per ownership category. If you deposit more than $250,000, you may need to spread your funds across multiple institutions or ownership categories to maintain full insurance protection.
Bump-Up CD
A Bump-Up CD, sometimes called a raise-your-rate CD, allows you to increase your interest rate during the term if interest rates rise. Bump-Up CDs typically allow you to request one rate increase during the term if you see that market rates have increased and your bank has increased the rates for comparable CDs.
Step-Up CD
A Step-Up CD, sometimes called a Step Rate CD, can provide an increased interest rate during your term. However, Step-Up CDs start with a set interest rate at the beginning of the term, then increase at scheduled intervals determined by the bank, such as every 6 months or annually.
Liquid CD
Liquid CDs, also called No-Penalty or No-Catch CDs, allow you to withdraw money before the CD term ends without incurring a penalty. Typically, you must wait a certain amount of time before withdrawing the money, usually seven days. You're allowed one withdrawal during the term. Most banks have different policies for their Liquid CDs.
These CDs may have lower rates than fixed-rate CDs, but a higher return than a standard savings account. They also are a little more flexible than Traditional CDs.
No-Penalty CD
No-Penalty CDs are essentially the same as Liquid CDs. They're particularly valuable in uncertain economic environments where you might need access to your funds or where interest rates are expected to rise.
Callable CD
With a Callable CD, the bank reserves the option to "call" back the CD before it matures. Callable CDs typically offer higher interest rates than traditional CDs. However, if market interest rates drop, the bank could opt to redeem your CD.
You would receive the principal and any interest that has accrued. Then you would need to find a new place for the money in a climate of falling interest rates.
Brokered CD
A Brokered CD is issued by a bank but sold through a brokerage firm. Brokered CDs offer the convenience of shopping for the best CD rates from multiple banks through a single brokerage platform.
Brokered CDs also can be traded on a secondary market. You can withdraw money early without a penalty by selling the CD. However, there is the risk that your CD may lose value when sold. When buying a brokered CD, it's vital to know whether it's a new issue coming directly from a bank or a secondary CD. It can be a little more difficult to determine the potential yield on a secondary CD.
Zero-Coupon CD
"Coupon" is a term for the interest rate paid for a bond. A Zero-Coupon CD gets its name from the fact that it pays no interest during its term. Instead, you buy the CD for less than its value at maturity. For example, you might pay $900 for a Zero-Coupon CD that can be redeemed for $1,000 in five years.
A potential drawback is that you must declare the accruing interest as income each year and pay taxes on it, even though you don't receive the gains until the CD matures.
IRA CD
An IRA CD is held in a tax-advantaged Individual Retirement Account. IRA CDs combine the security and predictability of certificates of deposit with the tax advantages of Individual Retirement Accounts.
It's a low-risk placement of money, but younger individuals would be giving up the higher returns that are possible with mutual funds or other long-term options. IRA CDs may be most appropriate for risk-averse individuals or those nearing retirement who prioritize capital preservation over growth.
Add-On CD
Most CDs do not allow you to deposit more money during the term. Add-On CDs are more like a savings account because they allow you to make deposits into it. The number of deposits allowed may vary from bank to bank, and there could still be penalties for early withdrawals.
Foreign Currency CD
Foreign Currency CDs are not as predictable or reliable as Traditional CDs. The money you deposit is tied to the value of foreign currencies, so there is no guaranteed return. They might yield higher returns, but they involve a level of risk that is not typical of CDs. By the end of your CD's term, you could have lost money.
Foreign Currency CDs generally appeal to institutions and people with a high tolerance for risk and in-depth knowledge of currency markets.
What CD is right for me?
Choosing the right type of CD requires careful consideration of your goals, risk tolerance, and need for liquidity. The decision should align with your broader financial strategy and personal circumstances.
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Safety = Traditional CD. If safety of principal is your primary goal, a Traditional CD might be a solid choice. Traditional CDs offer complete predictability with FDIC insurance protection, making them one of the safest options available. With a fixed interest rate, you know how much your CD will be worth at maturity. It's easy to budget for future expenses. People who prioritize capital preservation can still have an opportunity to realize somewhat higher returns than they might find with savings accounts
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Flexibility = Liquid or No-Penalty CD. If flexibility is important, then a Liquid or No-Penalty CD might be a good choice. These CDs allow you to access your funds without incurring early withdrawal penalties. This flexibility is particularly valuable if you're uncertain about your future cash flow needs, think your financial circumstances might change, or want the option to take advantage of better opportunities that might arise. You might sacrifice some yield compared to Traditional CDs, but peace of mind and flexibility could be worth the trade-off
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Large deposit = Jumbo CD. For someone with a large amount of money to deposit, a Jumbo CD might be a good choice. Jumbo CDs are specifically designed for substantial deposits, typically $100,000 or more, and may offer slightly higher interest rates than standard CDs. Higher rates can make a meaningful difference on large deposits. Jumbo CDs can be an effective component of a diversified savings strategy. You'll just need to stay aware of the income tax implications and the level of FDIC coverage
FAQs
Generally, you cannot lose money on a CD if it's held at an FDIC-insured institution and you don't withdraw funds early. CDs are considered among the safest vehicles available because they offer fixed returns and are protected by federal deposit insurance to at least $250,000 per depositor, per bank, per ownership category.
However, you could face penalties if you withdraw money before the maturity date. Penalties could reduce your earnings and possibly even cut into your principal.
The main differences between CDs and savings accounts are the accessibility, interest rates, and commitment requirements.
CDs require you to commit your money for a specific term and typically offer higher interest rates in exchange for this commitment. Savings accounts generally provide immediate access to your funds but usually offer lower interest rates.
With a savings account, you can make deposits and withdrawals as needed. CDs generally prohibit additional deposits and charge penalties for early withdrawals.
CDs are better suited for funds you won't need to access during the term. Savings accounts are good for emergency funds or money you might need to access regularly.
A fixed interest rate remains throughout the entire term is one of the key features of Traditional CDs.
However, some specialty CDs do have changing rates. Step-up CDs automatically increase at predetermined intervals and bump-up CDs allow you to request a rate increase during the term, under certain conditions.