Certificates of deposit, commonly referred to as CDs, are deposit accounts that earn a fixed interest rate over a set term.
While some CDs offer higher APYs, there are penalties for touching the funds before the term ends. There are also other requirements, so it's important to read the fine print before you open a CD.
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How CDs work
Money in a CD earns a fixed interest rate for a specific amount of time. Term lengths range from three months to five years, though some banks offer 10-year CDs. Typically, the longer the term, the higher the APY.
There is a tradeoff: In most cases, you can't access the funds before your term ends without paying an early withdrawal penalty. That penalty varies, but it's usually based on the interest you would have earned over a certain number of days or months.
Unlike high-yield savings accounts, which have variable APYs, CDs are locked into the rate they had when you opened the account. That's a good thing if interest rates drop after you opened the account. But if they go up, you could miss out.
CDs usually don't have monthly fees and they are FDIC-insured, making them a safe investment vehicle.
In most cases, savers can't make additional contributions to their CD during the term. There are add-on CDs, however, that allow you to make additional contributions throughout the term at the same locked-in interest rate.
When the term has ended, or the CD "matures," you can withdraw your deposit and any interest you've earned or roll over the funds into a new CD. Most banks will automatically roll your maturing CD into a new one if you don't give specific instructions.
When to open a CD
Putting money in a savings account can help you plan for milestone financial moves, such as buying a new car or putting a down payment on your first home. But that money is still easily available, leaving the temptation to withdraw funds for other reasons.
If you are serious about a medium- or long-term financial goal, opening a CD offers a higher interest rate than a savings account and greater protection against making early withdrawals. However, this also means it's not a great option if you don't have a robust emergency fund, and may be surprised by unexpected expenses.
Because the APY on a CD is fixed, your money will grow predictably without the volatility of the stock market.
Build your emergency fund with a high-yield savings account
Types of CDs
When shopping for a CD, there are a lot of variables to consider, including the APY, term and minimum deposit. Beyond that, there are actually different types of CDs, though not all institutions offer every kind.
Traditional CD: A standard certificate of deposit with a fixed interest rate and a set term. Savers agree to leave the funds untouched until maturity or face early-withdrawal penalties.
High-yield CD: These CDs earn above-average interest rates, more than double the national average in some cases. Typically, high-yield CDs are offered by online-only institutions.
Jumbo CD: In return for a higher rate, these CDs require a large minimum deposit, often at least $50,000.
Bump-up CD: If a bank's CD rates increase, savers with a bump-up CD can request a higher rate before maturity.
Add-on CD: Unlike most CDs, savers can deposit more money after opening their account.
No-penalty CD: Money can be withdrawn before the term ends without penalty, usually after a brief lock-in period.
Brokered CD: Because these are purchased through a brokerage firm, you can access CDs from many banks (with potentially higher rates) and trade them on a secondary market before maturity. That means they have a greater risk, however.
IRA CD: An independent retirement account in which all the funds are invested in certificates of deposit (CDs). It's a low-risk option that combines the stability of a CD with the tax advantages of an IRA.
CDs are popular savings options, but they do have drawbacks.
Pros of CDs
- Fixed rate means predictable earnings
- Higher return than a traditional savings account
- Can choose terms ranging from a few months to ten years
Cons of CDs
- Typically can't touch funds until the term ends without paying a penalty
- Usually cannot add funds once the account is opened
- Lower returns than stocks or mutual funds
- Fixed rates might not beat inflation over time
FAQs
What's a CD rate?
The rate for a certificate of deposit is the amount of interest it earns for the account holder, expressed as an annual percentage yield (APY). Unlike traditional and high-yield savings accounts, CD rates are fixed, providing predictable earnings.
Do CDs have fees?
Unlike some savings accounts, CDs typically have no monthly fees. In most cases, however, you will have to pay a penalty if you withdraw funds before the CD matures. Some CDs also require a minimum deposit to open.
Are there 10-year CDs?
There are CDs with 10-year terms, mostly offered by online banks. While they provide a guaranteed return with no risk, the market historically delivers much better returns over the same period.
Can you lose money on a CD?
Banks offering CDs are FDIC-insured, so there's no risk of losing your money up to the $250,000 limit per account holder. You can lose interest or pay a penalty if you withdraw funds before your CD matures. In addition, the value of a brokered CD can drop below the purchase price if it's sold on the secondary market.
Do you have to pay taxes on a CD?
Interest accrued on a CD is taxed as ordinary income. You must report the interest on your tax return for any account earning over $10 in one year.
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