What Is a Certificate of Deposit? How These Low-Risk Tools Can Fit Into Your Savings Plan

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A certificate of deposit, or CD, is a low-risk way to earn a guaranteed return on your savings, in exchange for locking up your balance for a period of time. 

CDs are a great place for money you want to set aside for a specific purpose, like buying a new car or taking a dream vacation. They can also be useful for locking in a great interest rate when rates are falling. 

You can find CDs from many banks with terms as short as one month and all the way up to 10 years. “In most cases, the longer the length of the CD, the higher the interest rate,” says Bobbi Rebell, author of Launching Financial Grownups and host of Money Tips for Financial Grownups podcast. 

It’s important to consider more than just rates when choosing a CD though — especially in today’s rising rate environment. Locking up your money for a long time now can make it difficult to take advantage of potentially higher rates in the near future.

This guide will help you learn everything you need to know about CDs and how they can help you accomplish your savings goals. 

Certificates of Deposit: What to Know

A CD is a type of deposit account with a fixed interest rate and fixed term. You’ll need to deposit your entire balance upon opening, and typically cannot make any additional contributions until maturity. In return for keeping the balance in the account for the entire term, you’ll earn interest on your deposit. If you do need to make a withdrawal before the CD matures, you’ll pay a penalty fee.

Here are a few basic terms to know about CDs: 

Annual Percentage Yield (APY): The rate of interest (on an annual basis) you can earn on deposit accounts like CDs.

Compounding Interest: The interest that your CD accrues over a given period of time. Some accounts accrue interest daily, while others do so monthly or annually. Compound interest is when the interest you earn is added to your principal balance, so you can earn interest on the interest.

Deposit: The amount of money you put in the account. For CDs, you are typically only allowed a one-time intial deposit. Some banks require a minimum amount, while others don’t.

Term: The time frame you agree to keep your money in the CD and earn interest. CD terms may range from one month to ten years.  

Maturity: The end of a CD term, when you can withdraw your balance (including interest) without penalty, or roll it over into a new term.

Withdrawal Penalty: The amount the bank will deduct from your balance if you take money out before your CD reaches maturity. The exact withdrawal penalty varies by bank, but it is usually a portion of interest earned. 

How Does a CD Work?

CDs are a pretty straightforward way to earn interest: you put money in for a fixed term at a fixed interest rate. “Fixed” in this context means unchanged, so the term length and interest rate will not vary over the lifetime of the CD. 

When the CD term ends and the CD reaches maturity, you’ll get your principal balance back plus interest. If you open a one-year CD with a 4% APY, for example, and deposit $500, you’ll have about $520 when your CD matures. 

The risk, however, is the chance that you may need access to your money before the end of the CD term. In that case, you’ll be charged a withdrawal penalty. Usually, the penalty is equal to a few weeks or months of interest, depending on your bank.

For a CD to work, you should be confident that you can stick to the terms you agree to when you open your account. Before locking away your savings in a CD, take time to choose your term length, interest rate, and deposit carefully.

The 7 Types of CDs

CDs come in different varieties that can all offer various levels of flexibility, risk, and potential interest earned. Here are a few different types of CDs to know before you decide: 

1. Standard CDs

Standard, or traditional, CDs are commonly found at most banks and credit unions. This type of CD is the type we’ve described throughout this guide. You’ll earn a return on your deposit at a fixed rate for a set period of time. Some banks require a minimum deposit for standard CDs. When the CD matures, you can withdraw the money penalty-free. However, if you need the money before the CD reaches maturity, you’ll pay an early withdrawal fee.

Pros

  • Fixed interest rate

  • Offered at most banks and credit unions

Cons

  • Cannot make additional contributions

  • Withdrawal penalty if you take money out before it reaches maturity

2. No-Penalty CDs

No-penalty CDs offer much more flexibility. Like other CD types, you’ll still have a fixed rate and term, but you if you need to take out your money before the CD matures, you won’t pay a penalty. 

However, there are still a few restrictions: you generally must take out your entire balance if you withdraw early, and there may be a waiting period between account opening and when you can withdraw penalty-free.

No-penalty CDs also have fewer term options, which could limit your potential interest, and may require a higher minimum deposit. Many of the best no-penalty CDs today carry interest rates comparable to high-yield savings accounts.

Pros

  • Flexibility to withdraw money without paying a penalty

  • Usually available in shorter term lengths

Cons

  • Restrictions on partial withdrawals

  • May require a higher deposit

  • Potentially lower interest rates than standard CDs

3. Bump-Up and Step-Up CDs

When interest rates are rising, bump-up and step-up CDs can help you keep up with the option to get higher interest even after you’ve locked in a rate. 

With a bump-up CD, you’ll have the option to request a one-time interest rate adjustment on your account over the lifetime of the CD. In a rising rate environment, a bump-up CD can help you get the best return if your bank is steadily raising interest rates. 

A step-up CD also works best in a rising rate environment. Like a bump-up CD, the bank may raise your interest rate; but it requires less tracking on your part. These CDs will automatically increase interest rates on a fixed schedule.

Both can yield a great return on your savings, but these two types of CDs won’t be as valuable when rates are falling.  

Pros

  • A chance to increase your interest rate in a rising rate environment

  • You’ll get a better return on your interest

Cons

  • Not as valuable in a low-rate environment

  • You can only raise your interest rate once during your term

4. Callable CDs

Callable CDs are a type of account in which the bank can “call” your CD before it reaches maturity. That means you’ll get your principal balance, plus interest earned on the CD before your expected term ends.

“A callable CD gives the bank the option to pay off your CD early,” says Marty O’Leary, a certified financial planner and founder of Stadium Financial, a financial planning firm in Lake Murray, Florida. “Normally this would be done when rates are going down.”

Callable CDs can come with higher-than-average interest rates to entice people, says O’Leary, but they’re a more risky choice. You’ll lose any potential interest for the remainder of the term after your account is closed and potentially have lower-earning options to replace it with than you did before.

Pros

  • May have higher interest rates compared to other CDs

Cons

  • Banks have the power to call your CD before it reaches maturity

  • Cannot guarantee a return for the full term of your CD when rates are falling

5. Brokered CDs

In addition to banks and credit unions, you can also get a CD at a brokerage firm, such as Fidelity or Vanguard. Brokered CDs are very similar to traditional CDs, but offered by a broker. Brokered CDs can be useful for near-retirees looking to take on safer savings options within their investment accounts.

“You get nice choices all in one spot,” says O’Leary. “The main advantage, though, is that you can buy them in your investment accounts.” If you already have a brokerage account, you can use money in the account to purchase a brokered CD as part of your investment portfolio.  

However, if you sell a brokered CD before it matures, you’ll still pay a penalty of a certain amount of interest, just like a traditional CD. Brokered CDs also come with brokerage fees, so it’s best to weigh the upfront cost and return to get the best value.

Pros

  • You can buy brokerage CDs directly in your brokerage account

  • Often have more options for terms and higher interest rates

Cons

  • You may be responsible for brokerage fees

  • You may still pay a penalty if you sell your CD before it matures

6. Jumbo CDs

Jumbo CDs are like traditional CDs, but they require a larger minimum deposit. Some banks may have minimum deposit requirements up to $100,000 or more to open a jumbo CD. 

“They might have slightly better rates because you’re committing more of your money to it,” says O’Leary. “Otherwise, it’s going to operate just like a traditional CD, there are no real surprises there.” But today, many banks offer rates similar rates on jumbo CDs as traditional CDs.

Pros

  • Usually comes with a higher interest rate

  • Less risky than volatile markets

Cons

  • Requires a larger minimum deposit

  • No liquidity for the higher required minimum deposit

  • Very large deposits could perform better in other investment accounts

7. Add-On CDs

Add-on CDs give you the flexibility to add more money to your CD after your initial deposit. For instance, say you initially deposit $10,000 into a CD, but you decide to add $1,000 a few months later when you receive an annual bonus. That’s possible with an add-on CD.

However, when rates are rising, short-term traditional CDs may still be the smarter option. “I don’t think [add-on CDs] are really attractive right now,” says O’Leary. “Rates are going up, and a few months from now, a new CD is going to have a higher rate than what you can add to that old CD.” 

Add-on CDs could be more lucrative in a falling rate environment since you’ll maintain the same rate you locked in even when you deposit more cash. 

Some banks have limits on how much money you can add and the number of deposits you can make over the lifetime of the CD.

Pros

  • Ability to add more money to your CD

  • Can increase your principal balance and return with additional contributions

Cons

  • May include requirements on additional contributions, including how much you can add

  • Could have better value when rates are falling

How to Open a CD

Opening a CD is pretty straightforward. If you’ve ever opened a new bank account, the process is similar.

After you’ve found a CD that offers the right term, interest rate, and minimum deposit for you, take a close look at the account details, including how you’ll access your account, the withdrawal penalty, and any other fees. 

Then, you can open your account. With an online bank, it can take as little as a few minutes. You’ll need your Social Security or tax identification number, personal information, and the deposit you’ll use to open your CD.

Make sure you have the account information for another bank account too, which you can use to transfer your deposit.

How Much Should You Put in a CD?

CDs are good for saving toward a specific goal, says Cory Moore, CFP and founder of Moore Financial Planning. 

For example, a down payment on a car, or money you want to put toward your wedding. A CD with the right term length can help you stash the money you’ve already saved in a safe place without the temptation to spend it.

You may also want to use the interest you’ll earn to your advantage when you’re deciding how much to deposit. If you know how much you’ll need to reach your goal, you can use the fixed interest rate to calculate how much you should deposit to ensure interest will cover the remainder.

The CD’s minimum required deposit can be another way to help you determine how much to save. Not every CD requires a minimum deposit, but many do. Some require a starting deposit upwards of $5,000. Before opening an account, always compare deposit requirements to make sure you’re able to meet the minimum amount. 

How to Calculate Your CD Return

The return you’ll earn from a CD is based on the term, amount you deposit, and the interest rate. CDs most often carry fixed interest rates, so you can calculate your return upfront without any risk of it changing over the lifetime of the CD. 

The calculator below can help you see exactly how much you can earn with different interest rates and deposits on various CD terms. 

For example, say you open a one-year CD with a 4.25% APY and you deposit $2,000. If you plug those numbers into the calculator below, you’ll see that you can earn a return of $85 on the CD by the time it matures.

You can use the same tool above for your own savings: simply input the CD term, interest rate, and your minimum deposit to determine how much interest you can earn.

How are CD earnings taxed?

Like any type of savings account, you will need to report your earnings every tax season.

The interest that you earn on your CD is considered income, says Rebell. Ahead of tax season, your bank will send a 1099-INT stating how much interest you’ve earned over the course of the year. You or your tax preparer will need to count the interest as income on your return. Generally, you must report any interest that exceeds $10.

CDs Compared to Other Savings Accounts

CDs, high-yield savings accounts, and money market accounts are all low-risk, interest-earning accounts. Even though you can earn interest on each of these accounts, they’re meant for different goals and financial needs.

Compared to high-yield savings accounts and money market accounts, CDs are best for longer-term goals and money you’re willing to set aside for a while. 

“Let’s say you’re trying to buy a house in the next two to three years. A CD is probably the best place for you to begin,” says Chan. With a CD, you’ll be able to set the money aside to earn a return for when you’re ready to enter the housing market.  

Here’s more about how other high-earning savings options compare to CDs: 

High-yield savings account

High-yield savings accounts make a solid foundation for any financial plan, according to experts.

If you have money you may need in three months or less, a high-yield savings account is the best type of account for liquidity, says Tony Chan, CFP, investment advisor, and tax planner at Crossroads Planning in Orange, California. For example, you can keep an emergency fund in a high-yield savings account, or cash you’ve set aside for an upcoming car repair or home renovation.

High-yield savings accounts carry variable interest rates. That’s a good thing when rates rise, since you can earn more over time than the rate offered when you open your account. But if rates fall, so will your APY. Unlike traditional savings accounts, which can offer as little as 0.01% APY, the average high-yield savings account offer closer to 4% APY right now. Some online banks and credit unions offer even higher

One of the biggest differences between savings accounts and CDs is that with savings, you’ll have access to your savings whenever you need it. You can deposit and withdraw money whenever you want (though some banks may charge a fee if you exceed 6 withdrawals a month), making these accounts the best place for your emergency fund. 

Money market account

A money market account also offers more flexibility than a CD. Think of it as a savings account with checking account features. 

Like high-yield savings accounts, money market account interest rates are variable, meaning that the interest rate rises and falls over time. But a few added features often include check writing or debit cards and ATM access. However, while these accounts historically had great interest rates, today they offer slightly lower returns compared to CDs and high-yield savings accounts. 

If you know you’ll need frequent or quick access to your money, a money market account can be a good option. Just make sure you are willing to keep the minimum balance to avoid any fees. 

Here’s an overview to compare these accounts and choose the right one for you.

CDsHigh-Yield Savings AccountsMoney Market Accounts
Fixed Interest RateYesNoNo
Allows for Additional ContributionsNoYesYes
Early Withdrawal PenaltyYesNoNo
Check writing and ATM accessNoDepends on the bankCommon, but depends on the bank
FDIC-insuredYesYesYes

Are CDs Safe?

CDs are a low-risk way to earn a return on your savings. As long as you open a CD with an NCUA- or FDIC-insured financial institution, your CD is protected up to $250,000 per account in case of a bank failure. 

Because they’re insured and not subject to market volatility, CDs are safe compared to more risky investments.

“That’s a great safety net for a lot of people,” says Rebell. “It’s a very secure way to have your money grow and can be a great part of your investment portfolio.” 

A diverse portfolio with a mix of investments and funds that fit your goals can help you earn a better return in the long run than CDs alone. But incorporating CDs can help round out your investment strategy. For example, as you get closer to retirement, it’s smart to diversify your portfolio with safer investment options, such as CDs and bonds.

Building a CD Ladder

A smart strategy some CD savers benefit from is building a CD ladder. Especially as rates rise, a CD ladder can help you take advantage of higher interest offers and gain some added flexibility.

Here’s how it works:

First, divide your balance across multiple CDs that mature at different times. To do this, you can either open multiple CDs at once with varying terms (such as three, six, nine, and 12 months) or open a few CDs over time with the same term length, but spread the deposits at varying intervals so they mature at different times. For example, you could open one 12-month CD today, another in three months, and another in six months, and they would mature at different times over the next year. 

As each CD in your ladder matures, you can withdraw the savings (plus interest) or roll the funds into a new CD which builds onto your CD ladder. You’ll have access to your money and be able to take advantage of higher rates without locking all of your money away in one CD. 

Here’s a CD ladder made up of one-, two-, three-, four-, and five-year terms. This example is designed to take advantage of higher rates offered by five-year CDs while maintaining flexible access. Every time a CD within the ladder reaches maturity, it’s rolled into a new long-term CD.

Changing economic factors can also have an effect on the smartest way to build a CD ladder. Experts don’t recommend long-term CDs right now. Instead, stick to short-term CD ladders to take advantage of steadily rising interest rates. For now, it’s best to keep your CD ladders to two years or shorter, says Moore. 

Regardless of the terms you choose, CD ladders require a bit of work. You’ll need to keep track of your open CDs, balances, and average interest rates to ensure you’re getting the best return possible. And if you do need to withdraw the money from any of the CDs within your ladder before it matures, you’ll still pay an early withdrawal penalty.

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CD ladders: A cautionary tale 

Even with the flexibility of CD ladders, withdrawal penalties were still an issue for Andrew Griffith, CPA and an associate accounting professor at Iona University in New Rochelle, New York.  

He started by building a CD ladder with short-term CDs, which matured every quarter, to store money for his insurance deductibles.

“My goal was to, first, set aside funds to ensure that it was not in my bank account,” says Griffith. “So, it can’t be spent — out of sight, out of mind.”

After some time, he built more CD ladders for household expenses. He started a ladder made up of three-month CDs, which he would roll into one-year CDs at maturity to take advantage of the higher interest rates. Over time, he says he was able to cover up to 24 months of expenses with that ladder. 

The CD ladders worked in his favor, Griffith says, until he decided to buy a home. 

Griffith used the money that matured from his CDs to cover closing costs for the house, but he didn’t have the time to wait several months for all the CDs to mature and chose to pay the early withdrawal penalties. He paid fees that ranged from three to six months of interest for his CDs to cover the costs of his new home. 

“My solution was to pay the early withdrawal penalties to be able to access those funds to cover my closing costs,” says Griffith. While it wasn’t the timeline he thought he would have, he says, it still made economic sense.

Still, it’s not a tactic he’d recommend to others. 

“If I can hold off [on withdrawing early], I’d rather hold off because the goal is to put money in your pocket,” says Griffith.

Before opening a CD, experts recommend setting a goal for the money you’re setting aside. And always keep your emergency fund in a high-yield savings account that you can withdraw from quickly if necessary. 

“You need to know what your goals are,” says O’Leary. “If you have a financial plan, where does this fit into it? Is it just a short term storage for cash? Or is it a long term play as part of your financial plan?” 

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NextAdvisor’s Takeaways

  • Earn a fixed return on your savings over a fixed term with a CD.
  • You can only make one initial deposit and you must keep the money in the account until maturity. If you withdraw from your CD sooner, you’ll pay a withdrawal penalty. 
  • There are several types of CDs. Which one you should choose depends on your goals, the current rate environment, and how long you’re willing to set the money aside. 
  • You can create a CD ladder to take advantage of rising rates and have ongoing access to a portion of your money more frequently.

How Are CD Rates Determined?

Usually, credit unions and banks move rates on deposit accounts like CDs alongside the Federal Reserve’s interest rate moves. So as the Fed raises rates, banks tend to move savings and CD rates up, too. The other big reason for CD rate changes is that banks want to keep up with the competition (other banks vying for your deposits).

Over the past year, CD rates have gone up drastically. Earlier in 2022, they were less than 1%, but have since tripled across many banks and terms. That rapid rise is why experts don’t recommend locking in a long-term CD right now. 

Since the Fed hasn’t signaled that rate hikes will stop any time soon, CD and savings rates are likely continue rising in the near future. On the other hand, banks are also more likely to lower rates when the Fed rate range does drop. 

[Read More: CD Rate Predictions: When to Lock In for the Long Term, According to Experts]

Choosing a CD Term

A CD term is the amount of time you agree to leave your money in the account to earn interest. Most banks offer terms ranging from one month up to five or even 10 years. 

When the CD term ends, you’ll have access to your savings again, plus any interest earned. 

Deciding on a CD term largely depends on your goal for the money. For instance, if you’re stashing money away to buy a car, think about when exactly you’ll want to make your purchase. If you want plenty of time to decide, you may choose a one-year CD. But if you think you’ll make the purchase sooner, you may choose a six-month term.

“Remember that if you put money in a CD, that’s money that’s not necessarily as liquid as you might need,” says Rebell. If you withdraw early, you’ll be charged a withdrawal penalty.

That’s exactly why experts recommend keeping your emergency fund elsewhere. Even the shortest-term CD won’t help you if you take on an unexpected emergency expense that you don’t have the cash on had to cover. 

Consider economic factors

Before you decide on a CD term, also consider what’s going on in the broader economy and whether you expect rates to go up or down in the near term.

Experts recommend short-term CDs in today’s rising rate environment. Right now, 18 month to two-year CDs (or even shorter) can be good, as the Fed continues raising interest rates. If you choose a long-term CD, you could miss out on a bigger return if interest rates go up. Plus, you won’t have access to the money for the duration of the term unless you pay a withdrawal fee.

Here’s an example of how much you’d miss out on if you locked in a three-year CD with $500 at a 1.00% APY earlier this year compared to the current average of around 4.50% APY.

DepositAPYInterest EarnedBalance at Maturity
$5001.00%$5$505
$5004.50%$22.50$522.50

Longer-term CDs may be a good fit for your savings or investment strategy when rates are dropping. For example, if you choose a five-year CD with a 4.50% APY just before rates start falling, you’ll have a higher rate for the entire term, which will give you a bigger return.

What to do when your CD reaches maturity

Before opening a CD, you should have a goal for your CD so you’ll know exactly what to do with the money when the CD matures. You may be ready to use the money toward planned expenses, such as paying for a trip or covering school expenses. Or you may choose to put the money into another CD or savings account. 

Before your CD matures, compare interest rates on other savings accounts, too. Among other places to save your money, you may choose a high-yield savings account, or a treasury bill or bond with a slightly higher rate compared to CDs. You may also choose a riskier route by putting the money in stocks or real estate. 

Most importantly, make sure you know when your CD will mature and what you’ll plan to do next. 

“Don’t leave things on autopilot,” says Griffith. Many banks have grace periods, usually lasting 10 days after your CD matures. If you don’t withdraw the money or open a new CD with a higher interest rate, the bank may renew the CD, which may have a less-than-ideal APY when the grace period ends, he says. 

Should You Get a CD?

A CD can make a good addition to your portfolio if you’re looking for somewhere safe to store your cash, and you already have an emergency fund. Before getting a CD, think about the reason for opening the CD and how much money you’re willing to lock into a CD for a given term. 

Add up your deposit

Before opening a CD, make sure you have money set aside in a high-yield savings account as your emergency fund. You won’t be able to access the money deposited into the CD before it reaches maturity without paying a penalty, so this account type is best for other, non-emergency purposes. 

Most importantly, you should already have the money you want to open a CD before opening the account. You can only make one deposit and won’t be able to contribute anymore after that. If you’re still saving for the CD, it’s best to wait until you have enough money set aside. 

Consider the goal

Also think about what you need the money for, and how you can make both the deposit and interest you’ll earn to help you reach your goal. 

“I like CDs where we can back into a goal,” says Moore. “So if we know we have a certain payment due in six months we can know exactly what we need to deposit in order to meet that goal down to the penny.” 

A CD can also be a good discipline tool for tucking away money for a specific goal and avoiding touching it. But if there’s a chance you’ll need the money to reach your goal before the CD matures, you should consider putting the money in a liquid savings account.

Certificate of Deposit FAQs

What is the benefit of a certificate of deposit?

A certificate of deposit guarantees a return on your savings if you’re willing to set aside the money for a specific time frame compared to putting your money in a volatile market.

Is it smart to put money in CDs?

It depends on your savings goal. Experts don’t recommend putting your emergency fund in a CD. But if you’re saving for a home or new car, a CD may be worthwhile if you know you won’t need the money for a specific time period.

Do CDs ever lose money?

Generally, no. If you’re willing to keep the money in the CD until it reaches maturity, you’ll earn the expected return. However, if you withdraw the money before then, you’ll pay a withdrawal penalty, which is usually a few months or weeks of interest.

Is it better to put savings in CDs or stocks?

You may choose to put money in stocks if you have a longer time horizon and can withstand the uncertainty of the stock market, like retirement savings. Oftentimes, you may get a better return compared to CDs. However, if you don’t want to risk volatility or you have a shorter timeline and want a guaranteed return with less risk, a CD or other savings option can be a better option.

How do I choose a CD?

Usually, the goal is to find the highest interest rate for the CD term that you’re most comfortable with. You should also consider the required minimum deposit if the bank requires one, and the withdrawal penalty for your term.