If you have some savings lying around in an account, you should ask yourself, “Am I earning as much interest as I could be?” If you’re keeping your money in a savings account, the answer is usually no. Although some banks and credit unions do offer high-yield account options, a certificate of deposit (CD) will almost always provide higher returns. But is it the best option for you?
Learn how CDs work, the pros and cons, and how to decide if it’s the right financial move for you.
What is a CD and how does it work?
A certificate of deposit, or CD, is a federally-insured savings account that usually offers a higher interest rate than a savings account. How much higher? Well, according to the FDIC, the average national interest rate for savings accounts sits at 0.09%, while the average rate for a 12-month CD is 0.54%.
In exchange for the higher interest rate, CDs generally require you to leave the money in the account for a set period. Common terms range from one month up to five years. Generally speaking, the longer the term, the higher the interest rate.
You can withdraw your money early if you need to, but you’ll have to pay a fee. When you reach the end of the term, you can withdraw your money plus the accrued interest, or you can reinvest it.
What are the main features of a CD?
CDs usually have the following features:
- Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA).
- Fixed terms.
- Fixed interest rates.
- Renew options.
- Higher interest rates than standard savings accounts.
- Larger deposits and longer terms offer higher interest rates.
- Smaller institutions often offer higher interest rates.
- Minimum deposit requirement.
- Best rates are on Jumbo CDs (deposits over $100,000).
- Substantial penalties for early withdrawals.
Where can you find CDs?
Many banks and credit unions offer certificates of deposit (CDs). Shop around to find an institution that is insured by the FDIC or NCUA and provides a high return on investment. Pay attention to the minimum deposit amount, the interest rate, the types of CDs, the deposit term options, and the early withdrawal penalty.
How much can I earn with a Certificate of Deposit account?
The amount you can earn with a CD depends on the institution you choose to get the CD through, the amount you deposit, and the term. Below, find the national average interest rates on a $10,000 deposit. Compare rates of leading institutions providing CDs.
Here is a comparison of the average rate on deposit accounts with balances under $100K.
What are the main types of CDs?
There are several different types of CD accounts. These include:
- Traditional: Traditional CDs typically have fixed terms ranging from one month to five years, fixed interest rates, and early withdrawal penalties.
- Individual Retirement Account (IRA) CD: IRA CDs are for those who want to invest their retirement funds somewhere less volatile than the stock market.
- Liquid: Liquid CDs let you withdraw your money at any time without a penalty, but usually have lower interest rates.
- Jumbo: Jumbo CDs have higher minimum deposit amounts (often $100,000 or more), and usually offer higher interest rates as well.
- Step-up/Bump-up CD: These CD accounts allow for automatic interest rate increases or a one-time rate increase during the term. However, they often start with lower rates than traditional CDs.
Be sure to compare several different CD options to find the best value for your situation.
How much money do you need to open a Certificate Deposit account?
Minimum deposit amounts range from $500 to $1,000, depending on the type of account and the institution. However, they can go up to $10,000, $25,000, and even $100,000 for certain CD types.
Do you have to pay taxes on a CD account when it matures?
When a CD reaches full maturity, and you cash it out, the interest you earned is considered taxable income. The tax rate you pay on it depends on your tax bracket.
Interest income over $10 is reported on Form 1099-INT. You receive this form in the mail, which makes it easy to figure out how much you need to report.
What is a Certificate of Deposit laddering?
CD laddering is a strategy for those who want the higher interest rates of longer-term CDs, but don’t want all of their money tied up for five years at a time. You split up your money between varying CD terms so that one matures each year. Then, you can choose to cash it out or reinvest it.
For example, if you have $25,000 to invest, you’d invest $5,000 in five CDs with terms ranging from one year to five. After the first year, you reinvest the $5,000 from the one-year CD into a five-year CD. If you continue reinvesting in five-year CDs each year, after five years you will have a CD maturing each year at the five-year CD interest rate.
Pros and cons of CDs
Here is a list of the benefits and the drawbacks to consider.
- Higher interest rates than many savings accounts.
- Low-risk investment.
- Early withdrawal penalties promote saving money.
- Accounts are insured up to $250,000 for an individual account.
- Various types of CDs.
- The ladder strategy can allow for more liquidity.
- Typically lower returns than investing in the stock market.
- Early withdrawal penalty applies if you need your funds before the maturity date.
- A minimum deposit amount is required.
Is a CD a good investment?
If you have money that you want to put away for a while, a CD is a safe place to do so while earning a modest return. It can help you earn more than you would with a standard savings account, without increasing your risk.
Of course, you could potentially earn higher returns in the stock market. But these higher returns come with increased risk. If you’re looking for a low-risk investment option with a modest but reliable return, a CD could be an excellent investment.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.