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What is a Certificate of Deposit (CD)?

A certificate of deposit (CD) is a financial product sold by banks, credit unions and other depository institutions which offer an interest rate in exchange for you making a deposit at their bank for an agreed upon amount of time.  These products are popular with consumers because they tend to pay an interest rate premium above high-yield savings accounts due to their time commitment on behalf of the depositor.

Most financial institutions offer these products because of their guaranteed returns and funding protection from the FDIC or the NCUA. What varies between these financial institutions will be the terms they choose to offer to consumers.

This can include items like how much interest they will pay in exchange for your money being held over various terms, what penalties (if any) they will assess for early withdrawal, and how these funds are treated when the CDs mature.

Because terms can vary between depository institutions, it is important to shop around.  Depending on the market environment, financial institutions can provide a wide range of terms for their CDs.

For example, a brick-and-mortar-based bank might offer less competitive terms than would an online-only bank like CDs from CIT Bank who faces far lower costs of business.

Local credit unions can even pay a greater amount than a traditional bank because they are non-profit institutions, having greater flexibility to offer higher rates in exchange for your money.

Their net interest margins, or the average difference between the interest paid on deposits and CDs and interest earned on loans offered to borrowers, can be lower than traditional banks because they do not need to factor in a significant profit margin on their product offerings.

Further, some banks might offer special promotions with higher rates, unusual duration, rather than a usual lineup of CD terms in the 3, 6, 12, 18, 24, 36, 48 and 60-month increments, and penalty waivers.

As a result, having a willingness to purchase a CD from different institutions can often result in better terms for your deposited money.  In brief, review the following high-level characteristics of CDs:

CD Highlights:

  • CDs with the best rates pay higher interest than savings accounts or money market accounts due to the time commitment required with the product
  • CDs carry federal insurance through the FDIC or NCUA, representing safer, more conservative investments than stocks and bonds
  • A commoditized product, nearly all retail banking institutions offer CDs with a variety of terms rates
  • In the event you lock into a longer duration than you need, you may withdraw the funds by foregoing a certain amount of interest as an early withdrawal penalty (EWP) or surrender charge

How a Certificate of Deposit Works

When you set up a CD with a bank, you agree to keep a set amount of money in the account for the term agreed upon- usually anywhere from 90 days to 5 years. The interest rate is higher than a typical savings account because you agree to keep your money with the bank for an extended period of time.

In exchange, the bank agrees to award you a higher interest rate to compensate you for your loss of liquidity.

These income-generating assets have five major factors you should consider when selecting your CD include:

  1. Interest rate: Likely the biggest determinant for which CD to select comes down to the interest rate offered on the product. Because CDs are highly-commoditized, financial institutions often compete on price, in this case, the interest rate. This rate of return cannot change once the product has been sold.  Meaning, if you lock in a rate of 2.5% and interest rates tumble in the ensuing months, leaving an identical CD offered by this financial institution offering 1.00%, your rate of return remains the same.  On the contrary, if you purchase a CD and rates rise, you are stuck with a lower-rate of return than you could currently receive from the market.
  2. The term: Terms of CDs are fairly standardized, ranging from as short as 90 days (3 months) to 60 months (5-years) or longer. The CD will begin on the date of purchase and will end on the “maturity date.”  This is when your CD matures and you can then withdraw your money penalty-free.  Some banks do offer non-standard terms, like 11-months, 15-months or other term durations.
  3. Early withdrawal penalty: Commonly, financial institutions assess early withdrawal penalties if you choose to withdraw money from your CD before it matures.  Commonly, the institution assesses an early-withdrawal penalty in terms of months’ interest, with a greater number assessed for longer CD terms.  For example, if you have a 60-month CD and withdraw money a year early, the institution might assess a penalty of up to a full year of forfeited interest.  For shorter-term CD early-withdrawal penalties, the bank might assess three months’ interest if the CD term is below one year, or six months’ interest if it is between one-year and three.  The exact terms will vary by institution, with some waiving it altogether like at CIT-Bank with their 11-month CD.
  4. The principal: This component is relatively straight forward.  This represents the amount of money you agree to deposit as a lump-sum.  Some specialty CDs have different contribution methods, but most commonly, you deposit a lump-sum amount of principal upfront.
  5. The institution: This represents the institution who offers you the CD in exchange for holding your money.  This can be a bank, credit union or any other financial institution which accepts deposits and carries FDIC insurance coverage.

CDs have regular reporting and account statements provided by your financial institution.  They act like most other deposit accounts by which you receive electronic or paper account statements as well as confirmation of your periodic interest payments.  This can occur monthly, quarterly or any agreed-upon interval and will compound over time.

Who Should Open a CD?

man sitting at laptop thinking medium

CDs offer fixed, safe investments for your cash. Most carry federal depository insurance (FDIC or NCUA insurance) and interest rates can come in higher than those paid on most other consumer deposit accounts.

Institutions can offer higher rates on these products because they come with time commitments on your behalf as well as the ability to assess early withdrawal penalties if you need your funds sooner.

CDs are an attractive savings instrument for people who aim to earn more than checking, savings or money market accounts.  CDs don’t carry market volatility nor the risk of interest rate fluctuations.

If you have a desire to lock in an interest rate over a specified period of time without encountering market rate movements, a CD might be a good investment.

CDs vs. Savings and Money Market Accounts

Certificates of deposit are useful tools for saving money for a predetermined time and rate. They differ from savings or money market accounts by making an upfront commitment to stash your funds with this financial institution in exchange for a rate often more competitive than a saving account or money market account.

Other than the time and rate components, CDs also differ in the fact you cannot make additional deposits during their term.

Are CDs Safe?

It should be known that CDs represent one of the safest investments you can make for two primary reasons:

  1. CDs carry FDIC insurance coverage up to $250,000, protecting your CD investment if that institution should fail
  2. CDs carry fixed and guaranteed rates, protecting you against interest rate fluctuations seen in the market

While exceedingly rare not to carry the coverage, make sure the institution you choose for issuing your CD carries FDIC or NCUA insurance. Some carry private insurance but these institutions are very uncommon.

If you have more than $250,000 to invest in CDs, you may consider investing across multiple institutions to ensure all of your funds carry protection.

This protection comes standard on most depository accounts and associated financial products like high-yield savings accounts, money market accounts, debit cards, etc.

When Should I Open a CD?

evaluating investments

CDs offer a compelling place to invest your funds when you don’t need them now but will in the future.  For example, if you have extra cash in your possession and know you will want to purchase a home in the coming 2-3 years.

Purchasing a 24- or 36-month CD would guarantee you a rate of return above what most high-yield savings or money market accounts offer.

Another use could come from wishing to save a portion of your portfolio conservatively.  If you’d like to avoid the risk and volatility seen in the bond market, CDs provide this feature.

Placing money in a CD which earns a rate of return above inflation, you will absolutely ensure your money will appreciate in value.

Alternatively, CDs can provide an incentive to leave your money alone.  For those who might not have the discipline to control their spending, placing your money in a CD could help because you might face an early withdrawal penalty for tapping your account.

CDs act as a great store of your wealth in certain situations and can be a useful financial tool for young adults.

When complementing a portfolio of investments in stocks, bonds, alternative investment options, and many other assets, CDs provide certainty with a guaranteed return.

How Much Do I Need to Open a CD?

The amount of money needed to open a CD will vary by institution.  However, some may only offer their best rates if you exceed a certain amount.

On the other hand, CIT Bank only requires you to deposit $1,000 to receive their best rate.

In most cases, CDs only require a modest deposit to open, like $500 or $1,000.  Some require as much as $10,000 or even $25,000 to receive the best rate available.

How is CD Interest Taxed?

CDs serve many people as a low-risk, low-return passive income investment.

CDs earn interest periodically, such as monthly, quarterly or annually.  Like other interest-bearing investments, this interest will appear on your account statements as earned interest and will need to be reported on your annual tax return.

Sadly, while you can make money while you sleep with CDs, it does not qualify for passive income tax rates.

Confusion exists around this CD interest income as it cannot be accessed by the CD holder without incurring an early withdrawal penalty.  However, you do not pay taxes on this interest income when the CD matures.

Instead, you show these earnings in the year earned, regardless of the timing for your CD’s maturity.  These assets do not qualify as tax-advantaged investments unless held in an individual retirement account (IRA) or other tax-deferred type of investment account.

For assistance claiming this interest on your tax return, have a look at the best tax software on the market.

What Happens to My CD at Maturity?

When your CD matures, you have options to consider for how your funds will be handled.  Usually, 30-60 days in advance of your maturity, the institution will proactively reach out to inquire how you’d like to handle this maturing CD.  Typically, you will have three options for how to handle these funds:

  • Roll over the CD into a new CD. If you have a desire to roll your current CD into another one, the bank will gladly roll your maturing funds into the available CD which most closely matches your current CD.  For example, if you purchased an 18-month CD, the bank would consider defaulting your maturing CD funds into a similar term CD.
  • Transfer funds into another bank account. The funds can transfer into another bank account held at the institution like a checking, savings or money market account.
  • Withdraw the maturing funds. This includes transferring the funds via ACH, wire, or check.

Regardless of the choice you make, the bank will communicate a deadline for you to make your decision.  Often, they will indicate the default action for your funds should you not reply by the stated deadline.  Commonly, the institution will choose to rollover your funds into a similar CD to keep your funds held with the institution.

Who Offers the Most Competitive CD Rates?

Nearly all retail financial institutions like banks, credit unions and thrifts offer these products to their depositors.  To receive the best rates on CDs, you will want to shop around as you will find a wide variety of rates offered by brick-and-mortar only institutions and online-only banks.

Typically, the latter tend to offer higher rates because they do not need to finance the costs of maintaining a network of bank branches and can pass these savings through to depositors like you in the form of higher rates.

Young adults invest through digital-only and Fintech businesses more commonly because they have greater comfort working with digital-only businesses and recognize higher rates of return.

Online banks can offer competitively-priced CDs because of this corporate strategy.  You will often find this bank offers special promotions to compete with the best offers in the market, though may come with unusual durations like 11 months, rather than the standard 3, 6, or 18 months or full-increments you will likely see from traditional brick-and-mortars.

Some online-only bank CDs I’ve found include:

Of these offers, I’d recommend looking into CIT Bank’s CDs.  They appear to have some of the highest rates in the market for holding your money.

About the Author

Riley Adams is the Founder and CEO of WealthUp (previously Young and the Invested). He is a licensed CPA who worked at Google as a Senior Financial Analyst overseeing advertising incentive programs for the company’s largest advertising partners and agencies. Previously, he worked as a utility regulatory strategy analyst at Entergy Corporation for six years in New Orleans.

His work has appeared in major publications like Kiplinger, MarketWatch, MSN, TurboTax, Nasdaq, Yahoo! Finance, The Globe and Mail, and CNBC’s Acorns. Riley currently holds areas of expertise in investing, taxes, real estate, cryptocurrencies and personal finance where he has been cited as an authoritative source in outlets like CNBC, Time, NBC News, APM’s Marketplace, HuffPost, Business Insider, Slate, NerdWallet, Investopedia, The Balance and Fast Company.

Riley holds a Masters of Science in Applied Economics and Demography from Pennsylvania State University and a Bachelor of Arts in Economics and Bachelor of Science in Business Administration and Finance from Centenary College of Louisiana.