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CDs 101: Earn more on your savings today
Key takeaways
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CDs hold fixed deposits for set terms with guaranteed interest rates, offering predictable returns but limiting access until maturity
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Different CD types serve various needs, from traditional fixed-rate options to no-penalty CDs that allow early withdrawals without fees
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CD rates chiefly depend on Federal Reserve benchmarks, term length, and bank competition, with longer terms typically offering higher returns
Certificates of deposit, or CDs, are a type of financial account that's designed to hold a set amount of money for a specific amount of time. In return, the financial institution that issues your CD pays you interest.
CDs offer a fixed interest rate. CDs are a safe and reliable savings account option, making them a popular banking product.
How a certificate of deposit works
CDs are ideal for savers who don't need immediate access to their cash and want a predictable return. Here are a few key points to keep in mind when you’re deciding whether a CD is the right savings option for you:
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Your funds are fixed. While typical savings accounts allow you to deposit and withdraw money, CDs require that you deposit a fixed amount of money at the time you open the account. You generally cannot make deposits after that time
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A CD works on a fixed term. You agree to keep your money in the Certificate of Deposit for a set period, which can range from a few months to several years. If you need to withdraw funds before that time ends, you may have to pay a penalty
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Fixed interest rate. CDs usually have a fixed interest rate. It doesn't change for the length of the CD, regardless of what happens with market rates
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Low-risk and highly predictable. Since you know the amount of money in the account, the interest rate, and the period that your funds will remain in the CD, you may predict the amount of interest you'll earn without being subject to much risk
What should I look for in a CD?
In general, look for the highest interest rate. However, rates may vary according to how much you deposit and how long the term is. When choosing the term, think about how long you can go without having access to the money.
Banks offer several types of CDs to suit the needs of their customers. Others may offer you the chance to withdraw money early with no penalty.
Here’s a look at some popular CD options:
Traditional CD
Traditional CDs offer complete predictability. The annual percentage yield (APY) remains constant, so you know how much interest you'll earn over the term. The term lengths typically are from 3 months to 5 years or more. Generally, longer terms offer higher interest rates, rewarding customers for their extended commitment.
This type of CD is valued for 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 earned interest. Early withdrawal typically results in penalties.
High-Yield CD
High-Yield CDs are usually structured like traditional CDs but pay better interest rates. They're attractive to savers who want to maximize their returns while maintaining the security of a CD. However, not all banks offer this type of CD.
No-Penalty CD
No-Penalty CDs, also called No-Catch CDs, allow you to withdraw money before the CD matures without incurring a penalty. Typically, you must wait a certain amount of time before withdrawing the money, at least seven days, and you're allowed one withdrawal during the term.
These CDs may have lower rates than fixed-rate CDs, but a higher return than a standard savings account. They're particularly valuable in uncertain economic environments where you might need access to your funds or where interest rates are expected to rise.
Jumbo CD
Jumbo CDs require larger deposits than Traditional CDs. 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 to at least $250,000 per depositor, per ownership category, per Federal Deposit Insurance Corporation (FDIC) insured bank. 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.
Step Up CD
A Step-Up CD, sometimes called a Step Rate CD, can provide an increased interest rate during your term. Typically, a Step-Up CD has one interest rate at the beginning of the term, then the rate increases at scheduled intervals determined by the bank, such as every 6 months or annually.
Brokered CD
A Brokered CD is issued by a bank but sold through a brokerage firm. Brokered CDs enable you to shop for the best CD rates from multiple banks through a single brokerage platform.
Brokered CDs can also 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's a little more difficult to determine the potential yield on a secondary CD.
How does a CD fit into your savings plan?
CDs offer a safe place to earn interest on your money. Your deposit is protected to at least $250,000 per depositor, per FDIC-insured bank, per ownership category. In addition, your deposit will not fluctuate in value like stocks or mutual funds. You typically will know exactly how much you will earn by the end of the term.
CDs can help you grow your money for future goals rather than spending it now. The limited access can help you save for short-term or long-term goals, including:
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Education
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Travel
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Home improvement
If you're not sure what to do with your current savings, your recent tax return, work bonus, or a recently sold house or car, a CD could provide a safe and rewarding way to earn more interest on your money.
Pros and cons of CDs
If you're considering a CD, here are some things to consider:
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Pros. CDs typically offer higher interest rates than regular savings accounts. Most CDs offer a fixed rate of return. Deposits are insured to at least $250,000 by the FDIC
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Cons. You usually can’t get access to the money in a CD until it matures. If circumstances force you to withdraw the money, you might incur a penalty. And although CDs are safer than other options, the returns they provide may be lower
CD interest rates overview
When you understand how CD interest rates are set, you may be in a better position to make decisions about what term you want to use, how much you deposit, or what type of CD might best suit your needs.
The most important factor in the interest rates of CDs is the Federal Reserve’s benchmark interest rate. This rate is a major force in the overall economy, and CD interest rates rise and fall with it.
Another factor is the market conditions for an individual bank. It might offer special interest rates on CDs to attract customers and top the competition.
A third major factor is the term length of a CD. CDs with longer maturity dates typically have higher interest rates than ones with shorter terms. In this way, banks reward customers for leaving the money deposited for a longer time. However, given the right economic circumstances, you might find a short-term CD with a higher interest rate than one with a longer term.
CDs vs. other savings options
CDs don’t exist in a vacuum and it's important to examine how they stack up against other ways to save.
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CD vs. savings account. A savings account will allow you better access to your deposits. Unlike CDs, you can add money to your savings account with ease and make regular withdrawals with no penalties. However, CDs typically offer higher interest rates
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CD vs. money market account. A money market account works more like a checking account, and it also provides better access. Again, the CD may offer a better interest rate. Having greater access to your savings isn’t always an advantage. For example, if you have a vacation coming in six months, you can place money in a CD for that term and not worry about impulse spending that leads you to pull money out and come up short when it’s vacation time
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CD vs. Bonds. CDs and Treasury bonds both can preserve your capital, offer attractive rates with low risk, and limit your access. Treasury bonds, however, are exempt from state income tax. CDs don't offer a similar opportunity to lower your tax bill. There are many other types of bonds, including municipal and corporate. Some may offer better rates than CDs, but they're more complicated and may present more risks
How to choose the best certificate of deposit
CDs can be a valuable tool for your personal finances, but how do you choose the right one? For starters, look for banks that are FDIC-insured. This will offer protection for your deposit. Here are some other key factors to consider:
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Term length. CD terms typically stretch from 3 months to 5 years. It’s important to consider how long you can give up access to your deposit. Longer term lengths may mean a better interest rate, but if you have to pay a penalty for early withdrawal, that might not matter. Do you have a specific savings goal? A wedding in one year? Or a new car in three years? Go with a CD term that aligns with your savings goal
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Interest rate. Once you determine the right term, you might shop around to find the best rate
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Penalties. Make sure you understand what penalties might apply to your CD. Early withdrawal penalties can come as a set fee or as several days' worth of interest. They can even eat into your principal. No-penalty CDs are an option, but they also have rules on withdrawing money that must be carefully followed
FAQs
Generally, CDs are safe accounts. Deposits up to at least $250,000 at FDIC-insured banks are protected against bank failure. However, you could lose money in certain scenarios. For example, early withdrawal penalties can eat into your principal.
When your CD matures, the bank might automatically renew it for the same term at the current interest rate if you don't provide instructions. You typically have three options: renew the CD for the same term, renew with a different amount or term, or close the CD and withdraw your funds. Many banks provide a grace period after maturity to make your decision without penalties.
Yes, CD interest is considered taxable income by the IRS, even before the CD matures. You may be required to report any CD interest of $10 or more on your tax return, and banks provide a 1099-INT form detailing interest earned.
Most traditional CDs charge penalties for early withdrawal. However, no-penalty CDs allow you to withdraw funds before maturity without fees, though they typically require a minimum waiting period (often seven days) and may limit you to one withdrawal. These CDs usually offer lower interest rates than traditional CDs but provide more flexibility if you need access to your money.
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