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How to shop for cd accounts
Certificates of deposit (CDs) are a safe way to earn interest on your savings. But there is a catch. Your money won’t be as accessible as with a regular savings account. The good news is that they offer higher returns than you would get with a traditional savings account or checking account.
But how do CDs work? And when should you use them? Here’s everything you need to know about certificates of deposit.
What is a certificate of deposit (CD)?
Certificates of deposit, or CDs, are a type of federally insured savings account. They have fixed interest rates and set maturity dates. CDs typically have better interest rates than traditional savings accounts. And they don’t have monthly fees.
How do certificates of deposit work?
When you open a CD account, you’re lending your money to a bank in exchange for a guaranteed return. This is one way banks build up the funds that they need to make loans and turn a profit.
The investor deposits money in an account where it must stay for an agreed period to earn the promised interest. Typically, the longer the period, the higher the interest. In general, CDs provide a higher rate of interest than you could get from a standard savings account. However, you must agree to lock in (not withdraw) the money you invest for a set period.
Each CD has an established maturity date or term length. When you purchase a CD, you can choose the term length that best suits your financial needs — often six months, one year, or three years. Most CDs mature within five years, but you can find CDs with term lengths up to 20 years.
Many CDs come with a minimum deposit requirement, which can be $500–$1,000 or $10,000+ depending on the bank and type of CD.
Because the bank uses your locked-in deposit to make long-term investments, most CDs charge an early withdrawal penalty. This discourages you from using the funds before your CD matures.
Could you tell me more about CD early withdrawal penalties?
If you withdraw money before your CD term is up, you’ll likely have to pay a steep penalty. The severity depends on the terms of your CD — a longer term usually results in a higher penalty. The policy on early withdrawals varies from bank to bank, including penalty amounts as well as how the penalty is calculated.
Some banks charge an early withdrawal fee based on the amount withdrawn, while others charge based on the total balance of the account. Either way, these penalties can eliminate interest you’ve earned on your CD and possibly even eat away at your principal. That’s because many banks will dip into your principal if you haven’t yet earned enough interest to cover early withdrawal fees. You’ll lose out on money you would have gained while also losing some of the money you initially deposited. So you’ll want to avoid putting money in a CD if you think you’ll need it soon. Otherwise, you may end up walking away with less money rather than more.
Do I need to worry about any other fees with CDs?
In addition to early withdrawal penalties, some CDs come with other fees, as well. For instance, with a brokered CD, you may have to pay a flat fee or a percentage of the amount you are investing. If that’s the case, you’ll want to ensure the interest rate makes it worthwhile before locking in your money. Don’t open a CD account until you fully understand the potential fees associated with it.
Who should consider a CD account?
Senior citizens who need a portion of their investment portfolio in simple, safe, and predictable investments are the ideal candidates for CD accounts. But senior citizens aren’t the only people who can benefit from a CD account. You should consider a CD if you want a safe place to put your money without the low annual percentage yield (APY) of a traditional savings account.
Because you can’t dip into your CD whenever you want, CDs are a good option for those who struggle to save money. For the same reason, they are not the best place to keep your emergency fund.
What types of CD accounts are there?
With a traditional CD, you’ll have a fixed interest rate and withdrawal date. But other types of CDs come with adjustable rates and allow you to access your money before it matures. Here’s a brief overview of the various types of CD products available.
|CD Type||Features||What to Consider|
|Traditional CD||Pays a fixed interest rate for a certain period.||Early withdrawal penalty. Less flexibility.|
|Variable-Rate CD||Pays an interest based on the varying rate of an index fund.||Since rate will vary, you may earn more or less than you expected|
|IRA CD||Earns interest. Money is only taxed when it’s withdrawn.||Early withdrawal penalty.|
|Fixed-Rate CD||Pays a set interest rate for the term’s duration.||Liquid CDs, callable CDs, and traditional CDs are all examples of fixed-rate CDs.|
|Jumbo CD||Intended for investments of $100,000 or more.||Pays higher interest rates. The Federal Deposit Insurance Corporation only insures up to $250,000.|
|Brokerage CD||Available through a stockbroker or online brokerage.||May charge a flat fee or a percentage of the investment amount. Some brokered CDs may not be FDIC-insured.|
|Bump-Up CD||Gives you the chance to “bump up” to the higher market interest rate in the event rates go up during the CD’s term.||Only one rate increase is usually permitted.|
|Zero-Coupon CD||Available at discounted prices.||No interest is paid out until the CD has matured.|
|Uninsured CD||Not insured by any institution, not even the FDIC.||Typically pays a higher interest rate than traditional CDs. If the CD issuer goes bankrupt, you run the risk of losing your investment.|
|Thrift CD||Available through thrift institutions like credit unions and savings-and-loan institutions.||You may need to join the institution or hold another account with them to qualify.|
|Callable CD||It can be “called back” or closed by the bank at any time. It offers higher interest rates.||The bank can close the CD before its term is up if interest rates go down. You cannot cancel the CD if interest rates go up. (So you can’t free up the money to invest at the higher rate.)|
|No Penalty CD||No early withdrawal fee.||Pays a lower interest rate than a traditional CD.|
|Liquid CD||Permits withdrawals at all times.||Pays a lower interest rate than a non-liquid CD of the same term.|
|Add-On CD||Allows you to add money to your CD before its maturity. The added funds earn the same interest rate as those used to purchase the CD initially.||The majority of add-on CDs only allow additional deposits of a specified minimum amount.|
|Index-Linked CD||Associated with a specified index. Return might be 100% of the index performance or another percentage, such as 90%.||If the linked index declines, there may be no profit. In that case, you will just get back your principal.|
|Bear CD||Pays an interest rate inverse that of an agreed-upon market index. If the linked index declines, the CD collects interest.||This type of CD is typically used as a hedge against declining stock prices.|
|Bull CD||Pays interest at a rate linked with a rising index.||If the market goes into a bear phase and declines, you’ll receive a minimum rate that must be paid.|
Certificate of deposit rates and why they matter
Your CD rate determines how much interest you’ll earn. In general, the longer your term, the higher the interest rate.
Here’s what you can expect:
|Financial Product||National Average Rate *|
* Rates as of November 15, 2021. The savings account rate assumes a $2,500 average balance. CD rates assume average balances from $10,000 to $100,000. (Source: FDIC.)
CD account rates are generally higher than regular savings account rates. Historically, this was true even for CDs with the shortest terms. In today’s low-interest environment, however, a bank’s CDs may only beat its savings accounts if you go for a term of 6-months or more. Six months is not a long time to wait, though. And, as you’ll notice after doing a quick online comparison of banks, finding CD rates better than the national average is not too difficult.
If you need more consistent access to your savings, but still want a CD’s stable interest earnings, consider building a CD ladder.
They are easy to set up. Open several certificates of deposit accounts at once and stagger their maturity dates by a period of six months to a year. For example, if you had $5,000 to invest, you would invest $1,000 in a one-year CD, another $1,000 in a 2-year CD, and so on. Then, as each account matures, you’d reinvest that money in a new five-year CD. If you keep this up over the next decade, you’ll end up with all of your savings in longer-term (five-year) CDs, with a new account reaching maturity every year.
Depending on your savings goals, you can choose to set up a CD ladder with terms that expire every few months. Or you may want to take advantage of longer-term payouts by opening one-year, three-year, and five-year CD accounts.
By building a CD ladder, you can safely stretch your savings over time and meet your financial goals faster.
Pros and cons of CDs
Although CDs are a fairly solid investment option, they have their strengths and weaknesses.
Advantages of CD accounts
CDs are a safe, low-risk option. If you purchase a CD from a federally-insured bank or credit union, your money is fully backed by the government (up to $250,000). Keep in mind that, if you choose to purchase a CD account through a brokerage firm or independent salesperson, you’ll lose this protection.
Also, CDs usually offer higher returns than traditional savings accounts.
Plus, CDs are flexible, allowing investors to choose from many different term lengths. This lets you decide which option is best for your individual savings goals.
Disadvantages of CD accounts
When you invest in a CD, you lose access to your money for a set timespan. Even if you run into a financial emergency, it will be difficult to withdraw the funds you need. If you must take out your money, you’ll likely have to pay an early withdrawal penalty. You may have to forfeit your earned interest or reduce your principal.
Also, CDs don’t adjust to reflect the rate of inflation. Although you’ll gain consistent interest, your funds may not have as much purchasing power if inflation outpaces your interest rate.
And, although CDs are more reliable than stocks and bonds, they lack the potential for higher returns. If you opt to invest in CDs, you’ll miss out on the increased returns of more high-risk, high-reward investment opportunities.
Here is a list of the benefits and the drawbacks of CD accounts.
- Higher interest rates. CD accounts offer higher interest rates than most checking, savings, and money market accounts.
- Low risk. CDs give you the opportunity to earn some interest without the risk of investing in stocks and bonds.
- Many options. With many types of CDs available, you have a wide selection of options to help you find one that best fits your needs.
- Fixed rates and terms. Fixed rates and terms give you the peace of mind of knowing exactly how much money you’ll earn over a set period. If you adhere to the terms of your CD, you can expect to get back the entire amount of your original investment plus interest.
- Easy to understand. CDs are straightforward and easy to understand. This is not always the case with other investment strategies.
- Low liquidity. You won’t have easy access to your money. If you need to make an early withdrawal, you’ll have to pay a penalty.
- Lower earning potential. Your money may lose purchasing power over time if the rate of inflation exceeds the interest rates on your CD.
- Low returns. Though CDs offer higher rates than other bank accounts, the return is low compared to other asset classes. High-risk investments like stocks, bonds, and cryptocurrency offer higher returns than low-risk investments like CDs.
Alternatives to CDs
If you’re on the fence about investing in a certificate of deposit, you may benefit from one of these alternative investment options.
- High interest savings accounts. A high-yield savings account may offer a comparable or higher interest rate, while also giving you consistent access to your funds.
- Bond funds. Bonds usually have a higher interest yield than CDs because they come with more risk (though that risk level can change depending on the financial climate). Additionally, bond funds don’t usually have a withdrawal penalty, so you can use your money when you need to.
- Paying down high-interest debt. If you have credit card debt or other balances with double-digit interest rates, paying it off first will give you a higher rate of return than a CD.
- Dividend-paying stocks. You can earn a significantly higher rate of return by investing in a company that pays dividends. However, you’ll also be at the mercy of the market.
With more risk comes the potential for a higher reward, but you also put your principal on the line.
When do CD accounts make sense?
CDs are best for those who want to protect (and grow) their savings and can afford to stash their money away for months or years at a time.
If you know that you won’t need access to your money in the immediate future, you can safely store your funds for major purchases later down the road. Plus, if you struggle with impulse control, keeping your money in a CD is a great way to avoid dipping into your savings before you’re ready to make that big purchase. For example, you may benefit from a CD if you’re saving for a down payment on a mortgage, for retirement, or for your child’s college education.
CDs aren’t just for long-term savings goals, however. You can strategically use short-term CD accounts to give your money an extra boost since CDs usually offer higher interest rates than traditional savings accounts. This can be an excellent first step for those who are brand new to the investment world and want a guaranteed return.
(Given today’s low average rates, the shortest term CDs may not offer better rates than your savings account. This means that the short-term CDs you use strategically may need to be a bit longer than they needed to be in the past. The basic strategy remains sound, however.)
Overall, CD accounts are a safe investment opportunity for those who want to avoid the risks of the stock market.
How to choose a certificate of deposit
Here are some additional tips for making a final decision on selecting the CD that’s best for you.
Consider different CD types
In addition to the fixed rates of traditional CDs, some CDs provide adjustable rates, along with other potentially appealing features. For example, bump-up CDs allow for a one-time upgrade if market rates rise before your term ends.
Other types include indexed CDs and callable CDs.
Find out whether the CD is insured
Are you buying a CD from a brokerage firm or salesperson? If your CD is not government-insured by the FDIC, it’s imperative to ensure that you’re working with a reputable institution. Research your chosen firm thoroughly, and consider contacting your state’s consumer protection office. Be aware that brokers are not required to be licensed or certified, and they don’t have governmental oversight.
Avoid automatic rollovers
When your CD reaches maturity, you can opt to cash out or automatically roll over your funds into a new CD with the same terms. Before you choose, check with your bank and its competitors to see if you can land a better deal.
Frequently asked questions about CDs
How are CD earnings taxed?
Interest income is added to ordinary income and is taxed at rates according to the year’s income tax brackets.
So, if you are a single filer who earned $100 in interest income from a CD in the 2021 tax year and your taxable income was $60,000, the federal government would tax you $4,664 + 22% of your earnings over $40,525. That means you would owe $22 in taxes on your $100 interest, giving you a $78 net yield after federal taxes.
Interest income is reported on Form 1099-INT.
States that charge income tax will also tax interest income. Continuing from the above example, if you lived in California, you would need to pay an additional 8% in taxes on the CD earnings. (The 2021 California tax rate for individuals with $60,000 in taxable income is $1,672.87 + 8% of earnings over $48,435.) This would subtract another $8, leaving your net earnings at $70.
What happens to my CD at maturity?
When your CD hits maturity, you will have the option to withdraw the principal you deposited initially — along with the interest you earned over the term. At this point, you can often reinvest your money into another CD to keep earning. Some institutions let you opt to auto-renew CDs. But it’s often best to shop around before agreeing to another term to ensure you are getting the best rate for the time and money you invest.
Are certificates of deposit FDIC-insured?
The Federal Deposit Insurance Corporation (FDIC) covers CDs and other time deposits up to $250,000 per person at insured banks. The insurance covers the principal and any accrued interest. You can find out if a bank is insured by calling the FDIC at 877-275-3342 or using its directory tool.
If you buy your CD from a federally insured credit union, it will be insured by the National Credit Union Administration (NCUA) rather than the FDIC.
Do certificates of deposit compound interest?
CD accounts often do compound interest, but the frequency at which they do so varies by account. It could be on a daily or monthly basis. By looking at the annual percentage yield (APY) of a CD, you can see the amount you can expect to earn in one year with compound interest factored in.
Are certificates of deposit tax-exempt?
Certificates of deposit are not exempt from taxes. You will be charged income taxes on the interest you earn as part of your ordinary income.
What does CD stand for?
CD comes from a “certificate of deposit.” In the past, the certificate was a paper document that showed proof that your funds were held in a bank at a certain rate. Today, CDs don’t come with a paper certificate. But, more importantly, the money in a CD is still federally insured up to $250,000 per account at banks and credit unions.
What if I need to withdraw my money early?
If you withdraw your money from a CD early, institutions will typically charge a penalty that amounts to a portion of the interest you would have earned. For example, Ally’s early withdrawal penalties range from 60 to 150 days of interest. In most cases, the penalty you receive depends on the length of your CD term. Some banks do offer penalty-free CDs; however, they usually come with lower APYs.
How are CD rates determined?
The rates on a CD typically depend on the length of the term, the current interest rates in the market, and how much your bank predicts it can earn with your investment amount. The more you invest, and the longer your term, the higher your interest rate is likely to be. You can also watch market trends to see if interest rates are expected to rise, fall, or stay the same.
Are CDs safe?
CDs are one of the lowest risk investment options available. They are insured by the FDIC (or, in the case of credit unions, the NCUA) and generally have higher interest rates than savings or checking accounts. Maximize your returns by choosing a reputable bank with competitive APYs and ensure you can keep your money in the account until it reaches maturity.
Are certificates of deposit worth it?
As with any financial investment, you need to do your due diligence before moving forward with purchasing a CD. Whether a specific CD is right for you will depend on your financial goal and other factors, many of which we’ve reviewed above.
How should I compare CD accounts to find the best deal?
Before you open up a CD, make sure it is insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). By doing so, you can protect your CD in the event a bank or another financial institution fails. Aside from that, you’ll want to make sure you do your research to find a CD that best fits your needs.
For example, check the table above to see which CD type is best for your goals. You should also find out what fees and rates each account offers.
SuperMoney’s CD comparison tools make it easy to filter CDs based on your needs and preferences. Compare interest rates, term lengths, penalties, and customer reviews side-by-side to determine which offer is best for your financial situation.
Once you’ve chosen a CD, thoroughly review the disclosure statement and ensure you understand all of the terms before moving forward.