A Certificate of Deposit, or CD, is a special type of savings account that allows you to earn a fixed interest rate on your money for a set amount of time.
In exchange for a higher interest rate than a regular savings account, you agree not to touch your money until the CD term ends. If you withdraw the money early, you’ll usually have to pay a penalty.
CDs are available in many timeframes — from as short as three months to as long as 10 years. Let’s break down how CDs work and what makes them a good or bad fit for different types of savers.
How CDs Work
Opening a CD is very similar to opening a regular bank account. However, when choosing a CD, you’ll need to consider several key details:
- Interest Rate: Most CDs have a fixed interest rate, which means you’ll know exactly how much you’ll earn when the CD term ends. There are also variable-rate CDs that can go up (or down) if interest rates change during your term.
- Term Length: This is how long you agree to keep your money in the CD — such as 6 months, 1 year, or even 5 years. Once the term ends (called the maturity date), you can take out your money without paying a penalty.
- Principal: This is the amount of money you deposit when opening the CD. Most banks have a minimum deposit requirement.
- Bank or Credit Union Rules: Each financial institution sets its own rules for penalties, statement delivery (paper or digital), and whether your CD renews automatically after it matures.
During the CD term, your interest usually compounds monthly or quarterly, meaning you earn interest on both your original deposit and the interest you’ve already earned.
Why Consider a CD?
CDs are ideal for people who want to earn more interest than they would with a savings or money market account — but without the risks of investing in stocks or bonds. They’re great for saving for future goals like a car, home down payment, or vacation.
The longer the CD term, the higher the interest rate tends to be. This makes CDs especially appealing if you don’t need immediate access to your money.
CDs vs. Savings and Money Market Accounts
All three are safe places to keep your money, but they work differently:
- Savings and Money Market Accounts allow you to deposit or withdraw money at any time.
- CDs require a one-time deposit that stays untouched until maturity, in return for a higher interest rate.
CDs are better for long-term saving where you’re okay locking in your funds, while savings and money market accounts offer more flexibility.
How Are CD Rates Determined?
The interest you earn on a CD is largely influenced by the Federal Reserve. The Fed meets several times a year to adjust the federal funds rate, which impacts how much banks pay customers in interest.
When the Fed lowers rates (like in 2008 and again in 2020), CD interest rates usually drop. But when the Fed raises rates — like it did aggressively in 2022 due to high inflation — CD rates often climb.
Banks also set CD rates based on how much they want to attract deposits. A smaller bank needing funds may offer higher rates, while a large bank might offer less.
Are CDs Safe?
Yes. CDs are one of the safest ways to save your money. You’re guaranteed to get your principal and agreed-upon interest as long as you leave the money in for the full term.
Additionally, CDs are insured up to $250,000 per person by the FDIC (for banks) or the NCUA (for credit unions). Even if your bank fails, your money is still protected.
When Is It Smart to Open a CD?
CDs are a great option when:
- You have money you don’t need immediately but will use in the next few years.
- You want a low-risk way to grow your savings.
- You need help resisting the urge to dip into your savings (since early withdrawal comes with penalties).
They’re perfect for conservative savers who want reliable returns.
Pros and Cons of CDs
Pros:
- Higher interest rates than most savings accounts.
- Predictable returns with no risk of losing your money.
- Federally insured.
- Helps prevent unnecessary spending due to withdrawal penalties.
Cons:
- Penalties for early withdrawal.
- Doesn’t earn as much as stocks or other high-risk investments over time.
- Fixed interest rate could be a downside if market rates rise.
- Inflation can reduce your purchasing power over time.
Where to Get a CD
CDs are available through banks, credit unions, and online financial institutions. Many brokers also offer access to CDs. Shop around to find the best rates — don’t just stick with your current bank.
Minimum Deposit Requirements
Each institution sets its own minimum deposit amount, which can range from as little as $500 to $25,000 or more. However, many top-paying CDs are available with just $1,000 or $10,000 minimums.
More money doesn’t always mean a higher rate, so compare before committing.
Choosing the Right CD Term
Pick a term that matches your savings goal. If you expect to need the money soon, a short-term CD may be better. If you can lock away your money for longer and want higher returns, go with a long-term CD.
Keep an eye on interest rate trends. If rates are expected to rise, consider short-term CDs or those with variable rates. If rates are expected to fall, locking in a long-term CD now could be smart.
CD Laddering: A Smarter Way to Invest
A CD ladder involves splitting your savings into multiple CDs with different terms (e.g., 1-year, 2-year, 3-year, etc.). Each year, one CD matures, and you reinvest that portion into a new 5-year CD. This gives you access to higher rates without locking away all your money at once.
Taxes on CD Earnings
CD interest is taxable. Your bank will report it as earned income, and you’ll need to include it when filing your annual tax return — even if you don’t withdraw the funds right away.
What Happens When Your CD Matures?
When your CD reaches the end of its term, you’ll usually get a notice from your bank or credit union. You can then:
- Roll over into a new CD.
- Transfer the money into another account (like savings or checking).
- Withdraw the funds.
Most banks will automatically roll it over unless you tell them otherwise.
What If You Need to Withdraw Early?
If you take your money out before the CD matures, you’ll pay an early withdrawal penalty (EWP). This is usually equal to a few months of interest and is based on the CD’s length.
Some EWPs are so steep that you could lose part of your principal — so it’s important to understand the penalty before opening a CD.
Final Thoughts
CDs are a great way to grow your savings safely with predictable returns. They work best when you don’t need immediate access to your money. However, it’s crucial to compare interest rates, understand the penalties, and choose the right term for your needs.
And if you’re unsure whether a CD is right for you, speak with a financial advisor who can help you align your choices with your financial goals.
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