A certificate of deposit (CD) is a deposit with a fixed term and interest rate. CDs are different from savings accounts in that the institution holds your deposit until maturity, at which point you can then withdraw your money with its accrued interest.
Not having a certificate of deposit is basically like leaving free money on the table.
While CDs tend to pay more than high-yield saving accounts, you aren’t able to easily access the money you’ve placed into the CD until the end of its lifetime.
How Do CDs Work?
CDs work in a very similar way to the savings account, except there are a few crucial differences between the two. Upon signing the contract for a certificate of deposit and depositing a certain sum of money, called the principal, the interest rate (APY) is locked for the time in which you leave the money with the bank, called the term length.
The term length varies a lot, but it usually is either three months to five years long. If you try to withdraw your money anytime during the lifetime of the CD before the end of its term length, you will likely face early withdrawal penalties.
While you are unable to touch your money for some time, generally speaking, CDs offer higher returns on your money than savings accounts and high-yield savings accounts. It becomes a balance between how accessible your savings are and how much you can earn in interest.
As you approach the maturity date of the certificate of deposit, the bank will notify you so that you can plan accordingly. This is important, because you will only have a 1 to 2 week grace period to withdraw your money, otherwise the CD will renew for the same duration.
When Should You Get A CD?
After you’ve run through the eight steps of personal finance and established some savings, you can start thinking about making the most of what you’ve saved up so far.
A certificate of deposit is best after you have developed a robust set of savings in your high-yield savings account. With the proper strategy, you can make your money grow even more than before.
Think about this way: if you have $10,000 in your savings account, and everything else is pretty stable in your life, then you probably won’t need to have immediate access to all of your savings at that time. Why don’t you put some of your money into a CD to maximize your returns and leave the rest for your general day-to-day use?
There is no perfect way to split your money up, but you should definitely not put all of it into a CD. Sure, you’ll make a lot of interest, but what if you needed to access your savings for an emergency? Then you’d find all of it tied up in a certificate of deposit! Things would go south really quickly.
Pros and Cons of CDs
| Pros | Cons |
When Should You Not Get A CD?
You should not get a CD if you feel as though your current financial situation is unstable or if you feel like you need to have immediate access to your savings.
It would not be a good idea to lock up your life savings into a CD, only to realize that you’d have to pay early withdrawal fees to break out of the contract early.
Early Withdrawal From A Certificate of Deposit
We’ve been hinting at this throughout this article, but to be explicit, if you withdraw your money before the CD’s maturity date, you will face an “early withdrawal penalty” that depends on the institution.
However, for the most part, the withdrawal fees are usually based on how long the term length of the CD was and are often a function of the interest rate. Consequently, these fees are generally not too expensive, allowing you to pull your money out in a pinch.
CD Rates
Certificate of deposit interest rates generally vary on how the overall economy is doing. Currently, CD rates are particularly low due to the federal reserve’s interventions to dampen the recession.
| Certificate of Deposit | Term Length | Min. Deposit | APY as of 06/2020 |
|---|---|---|---|
| CIT Bank | 12 mo. | $1,000 | 0.35% |
| CIT Bank (no penalty) | 11 mo. | $1,000 | 0.35% |
| Marcus by Goldman Sachs | 12 mo. | $0 | 1.00% |
| Ally Bank | 12 mo. | $0 | 0.90% |
| TIAA Bank | 12 mo. | $5,000 | 0.60% |
| Discover Bank | 12 mo. | $2,500 | 0.80% |
| Capital One | 12 mo. | $0 | 0.50% |
CDs vs. High Yield Savings Account
Although we’ve briefly mentioned the differences between CDs and high-yield savings accounts, the table below summarizes everything:
| Certificates of Deposits (CD) | High-yield Savings Accounts |
| Higher interest rates than high-yield savings accounts | Lower interest rates than certificates of deposits, but still overall high rates |
| Your money is locked in for a specified amount of time | You have more access to your money, but can only withdraw money a total of 6 times a month |
| Safe investment insured up to $250,000 by the government | Safe investment insured up to $250,000 by the government |
| Online-only accounts allow for easier access and higher CD rates | Online-only accounts allow for easier access and higher saving account rates |
Are CDs Safe Like Bank Accounts?
Yes!
CDs are as safe as bank accounts; both products are FDIC-insured up to $250,000, meaning that if the bank you made the CD with suddenly fails, the government will make sure you get all of your money back, up to $250,000.
Only three things are guaranteed in life: death, taxes, and FDIC insurance protecting your certificate of deposits.
Where Can I Get a CD?
You can get one right now.
Most banks offer CDs, but you’ll want to shop around for the highest interest rate possible.
| Certificate of Deposit | Term Length | Min. Deposit | APY as of 06/2020 |
|---|---|---|---|
| CIT Bank | 12 mo. | $1,000 | 0.35% |
| CIT Bank (no penalty) | 11 mo. | $1,000 | 0.35% |
| Marcus by Goldman Sachs | 12 mo. | $0 | 1.00% |
| Ally Bank | 12 mo. | $0 | 0.90% |
| TIAA Bank | 12 mo. | $5,000 | 0.60% |
| Discover Bank | 12 mo. | $2,500 | 0.80% |
| Capital One | 12 mo. | $0 | 0.50% |
Do CDs Have Minimum Amounts
Unfortunately, to open some certificates of deposit, you may have to put in a minimum amount. For example, some CDs require you to have, at minimum, $1,000 or even $5,000.
However, some of the best CDs available in the market have no minimum. See the table above in “CD Rates” to see the types of certificates of deposits available, including their required minimum investments.
How Are CDs Taxed?
The interest you earn from certificates of deposits is taxed using your tax bracket. For example, if you receive $100 from a certificate of deposit in 2020 and your total taxable income for that year was $51,000, you’d face a 22% tax rate ($22.00 in taxes for your gains).
The bank where you have a certificate of deposit will issue you a 1099-INT statement when it’s tax season.
There Are Different Types of CDs
We’ve been talking about the good ole’ standard CD for some time now. However, it’s good to hear about the other types of CDs that exist.
No Penalty CD
Typical CDs charge hefty fees if you withdraw your money prior to the maturity date. However, some banks offer no-penalty CDs that allow you to withdraw your money whenever you want and cancel the CD.
Naturally, they offer lower interest rates, but it’s a perfect option if you need the flexibility (like if you are saving for the down payment on a home).
CIT Bank offers an 11 month no-penalty CD with a high yield, which is awesome.
Liquid CD
Regular certificates of deposits are faced with early withdrawal fees if you try to take your money before the end of the CD’s lifetime.
On the other hand, liquid CDs charge no early withdrawal fees if you take your money out before the end of the term length. However, liquid CDs mostly have the same interest rates as their savings account counterparts because of how they are functionally identical.
Are there any advantages? Not particularly, but we just want to make sure you are aware of all the products out there.
IRA CD
An IRA CD is simply a different investment method you use when creating an IRA account. The IRA CD is the same thing as the standard certificate of deposit described above but used in your retirement account to enjoy tax advantages.
Bump-Up CD
Typically, standard certificates of deposits have fixed interest rates, meaning that the rates cannot change during the term length of the CD.
However, what happens to your CD when the current interest rate is higher than the rate you’re locked into? Well, nothing happens—you’re just stuck with the rate you’ve originally signed up for.
With a bump-up CD, you can change the initial rate you’ve signed up with once during the CD’s lifetime. Now, you won’t miss out if the interest rate increases!
Callable CD
When you open a certificate of deposit, it is essentially a two-way deal: you promise to keep your money with the institution for a set time, and the issuer agrees to pay you interest in return.
A callable CD is unique in that the issuer has the power to nullify the contract anytime. However, they must still repay all of your money, so you won’t face any penalties if this does occur.
With this slight instability, you are taking on some additional risk, meaning that banks will compromise with you by offering slightly higher interest rates in return.
Zero-coupon CD
Upon completion of the term length of the certificate of deposit, you’ll receive a 1099-INT tax statement that indicates the total interest earned throughout the CD’s lifetime. However, this interest is all taxed at the time the CD expires.
A zero-coupon CD offers a unique strategy such that the interest earned over time appears in separate 1099-INT statements every year. This particular investment allows savvy investors to prevent having large sums of interest income appear in one year, which could help avoid taxation bracket creep.
Add-on CD
Say you wanted to add more money to your certificate of deposit. An add-on CD will allow you to deposit money to increase the CD’s principal. However, the amount of times you can add money to the CD varies from institution to intuition and is usually limited to once or twice through the CD’s term length.
Jumbo CD
Some institutions offer CDs with heightened interest rates if you have a considerable starting principal for your certificate of deposit. Conventional jumbo CDs require, at minimum, $10,000 and a going up to even $50,000 starting principal. The name, jumbo CD, simply refers to the substantial initial investment required to open the account.
Variable Rate CD
A variable-rate CD differs from a standard CD because the interest rate isn’t fixed for the duration of the agreement. That means you’ll be taking interest rate risk because the rate can fluctuate.
What Is A CD Ladder
What if I told you there was a way to keep your money somewhat accessible while maximizing your money over time?
This is the magic of the CD ladder.
We’ll show you how a CD ladder works, but it might require a bit of math and graphs—follow along carefully, and we promise it will be okay!
How To Build A CD Ladder
The idea of a CD ladder is to open multiple certificates of deposits with varying term lengths. For example, if you have $10,000 to put into a CD, but you don’t want to keep all of that money locked up for five years, you can open up five separate CDs for one, two, three, four, and five years and put $2,000 in each CD.
After each year, you’ll have immediate access to a portion of the money you initially invested. After each CD’s term length ends, you can reinvest that money into a new five-year CD or take that money out to pay down your student loans, for instance.
Why do you do this? Now, for each of the subsequent years to come, you’ll have access to a significant chunk of your money each year, while maximizing your returns using longer-term CDs.
The takeaway: in the short-run, you will make a little bit less than you could have had you invested all of your money in a single five year CD, but in the long-run, you’ll be making just as much as you could have by investing all of your money in five-year CDs with frequent access to some of your money each year. Don’t make the mistake of locking all of your savings into a CD!
CD Ladder Advantages
What sort of gains can you make using a CD ladder? Well, let’s compare it to making individual CDs for a wide variety of term lengths:
We can see that five year CDs will make us the most interest over ten years, but five year CDs also have the least flexibility in accessing your funds. However, while one year CDs offer the worst accrued interest over the same period, they allow you to access your money much more frequently.
CD ladders take the best of both worlds and make considerable amounts of interest while allowing you to access your money as frequently as one year CDs. The power of CD ladders is highlighted here.
A side note: if we did this over a 20, 30, or even 40 year time period instead, we’d find that the CD ladder ends up making the same interest as five year CDs alone. Limits. Who knew we’d see calculus in real-life.
Odd-Term CDs
While regular CDs are usually three, six, or twelve months, or two, three, four, or five years, odd-term CDs are a colloquial term for certificates of deposits that don’t follow the “norm.” For example, an odd-term CD might be seven months or 17 months.
The benefit? If you’re advanced, you could play around with these abnormal length CDs to try to maximize your returns with an even more advanced CD ladder. However, I do not think this is worth your time and is out of this article’s scope.
CD Rollovers
A CD rollover is just a fancy term for saying that when your existing CD term length ends, a new CD will be created for a prespecified term length. Normally, the new CD will start with your initial investment plus any interest it has accrued through its lifetime.
Now, I recommend against allowing CDs to automatically rollover. The issue is that if the certificate of deposit ends during a time where interest rates are low, then you could accidentally lock yourself into a bad rate for several years to come. Furthermore, you might foresee yourself needing that money in a month or two, so it wouldn’t be good if it suddenly got stuck in a CD.
CD rollovers are a tool used for pure convenience in automatically maintaining a CD ladder, for example. Still, it’s nice to keep a sense of manual control to ensure you can maximize your rates and control your money’s accessibility.
Direct vs. Brokered CDs
Direct vs. brokered CDs can be thought of as buying vegetables from a farmer’s market vs. the supermarket. Brokerage accounts such as Fidelity offer brokered CDs, acting as the “middle-man” between you and the CD’s institution in such transactions.
Since CDs are essentially securities, you can easily purchase one through your brokerage account since the paperwork has already been completed upon creating the account itself.
The exciting thing is that some brokered certificates of deposits can offer interest rates that are a few percentage points higher than direct CDs.
You might now ask, why would I ever get a direct CD if brokered CDs can offer even higher rates than their organic counterparts?
Well, firstly, not all brokered CDs are worth more than direct CDs. Secondly, if you need to withdraw your investment early from a brokered CD, the methodology is a bit more complicated than just paying a one-time fee—you’ll have to sell it in your brokerage account’s secondary market.
Certificate of Deposit FAQs
Certificates of deposit are FDIC insured up to $250,000, so you can’t lose your deposit.
At the end of the term of your CD, your CD will automatically renew after a 1 to 2 week grace period. During this grace period you can decide if you want to withdraw your money or not. If you let the contract renew, the interest rate will likely be different from the original CD depending on the current interest rates.
No, variable rate CDs typically have harsher early withdrawal penalties, but they are still very safe.
John Ta is an undergrad at the University of Pennsylvania and the founder of Penn’s first undergrad personal finance club, Penn Common Cents. As a first-generation college student, he had to learn everything about personal finance on his own and seeks to mend the financial literacy knowledge gap seen almost everywhere. John is currently studying for an MS in Chemistry and a BA in Physics (business & tech concentration), Biochemistry, and Biophysics and is interested in the intersections of finance and healthcare.