What is a CD Account?

If you’re looking for a secure way to earn modest interest, consider a certificate of deposit (CD). These savings products are a lump sum inverted for a set period of time with a set interest rate. Unlike a savings account, you can’t access the money in a CD until the term is complete without paying a fee. For that loss of liquidity, you typically earn a higher interest rate than in a savings account. Read on to understand what is a CD account, how it works and when you may want to use one for your savings goals.

What is a CD Account?

So, what is a CD account? CDs are government-backed securities that are one of the least risky investment options. CDs typically pay higher interest rates than savings accounts or money market accounts but still offer a guaranteed return. 

Key characteristics of a CD are set maturity terms, ranging from as short as one month to 10 years. You'll need to keep the money in the CD during the term or risk paying a penalty. The CD also has a set interest rate for the term. 

CDs are considered low-risk as they are government-backed. You can choose certificates of deposit from most banks, credit unions and brokerage firms. If you need your money back early, you can usually exit a CD with a fee. 

How Does a Certificate of Deposit Work?

A CD is a type of specialized savings account. CDs offered through banks or credit unions are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) up to $250,000. With a CD, you place a set lump sum into the account and receive a set interest rate. You choose the term and principal amount and can shop around for interest rates.

CD terms usually range from one month to 10 years. The annual percentage yield (APY) or interest rate for CDs is typically fixed and varies based on standard market interest rates. Current interest rates are often around 4% to 5.5%. You can find the current best interest rates here. Generally, the longer the CD term, the higher the interest rate.

Typical amounts for CDs range from $500 to $2,500 or more, but CDs are insured up to $250,000 per institution, per depositor at banks and credit unions, so you could hold multiple CDs. Many investors build a CD ladder with multiple CDs for various terms to take advantage of higher interest rates for longer terms while getting liquidity for shorter terms in case CD rates go up.

Pros and Cons of Certificates of Deposits

There are numerous advantages to certificates of deposits as one financial tool for building long-term wealth. However, they are not the best options for all financial goals. Here is an overview of the pros and cons of using a CD for your savings.

Advantages of CD Accounts

• CD accounts offer security, guaranteed returns, and higher interest rates compared to other savings products.
• CDs do not have monthly maintenance fees, providing a cost-effective savings option.
• CD ladders can be set up to maximize interest rates and meet financial goals based on various terms.

Disadvantages of CD Accounts

• CDs often offer lower interest rates compared to other investment options.
• In times of high inflation or rising interest rates, the returns on a CD may be limited.
• CDs lack liquidity as your money is locked in for the term unless you pay a fee to withdraw early.

Types of Certificates of Deposits

Now that you know what is a CD account, let's go into more detail about the different types of CDs you can consider.

• Standard CDs: Have terms from one month to 10 years with fixed interest rates, principal amount and terms.
• Bump-Up CDs: With a bump-up CD, the bank gives you the option to increase your APY during the CD's maturity term. Usually, you can increase interest once during the CD's term.
• Add-On CDs: With an add-on CD, you can make additional deposits to your initial invested principal and earn the same interest rates. Some CDs may stipulate the number of allowed add-ons per time period.
• No-Penalty CDs: You can withdraw your money without paying a penalty with these CDs. However, they typically have lower interest rates than other CDs.
• Jumbo CDs: Jumbo CDs are CDs with a large minimum deposit. There is no set minimum, so this varies by bank or institution, often from $25,000 to $100,000 or more. 
• IRA CDs: IRA CDs must be held in an individual retirement account. These CDs are offered by banks and credit unions specifically for retirement accounts. Find the best IRA CD rates here.

Factors to Consider When Opening a CD Account

When opening a CD account, consider the interest rate, term length, fees and minimum deposit. You'll want to consider your cash liquidity needs and other retirement and savings goals, including your retirement timeline, and to ensure you aren't reducing liquidity too much or locking in low interest rates long-term. 

If you shop around, you may be able to get comparable interest rates on short-term CDs and then consider re-investing the funds or using other savings vehicles. For example, if you have a high-yield savings account with a 4.5% interest rate, you'll want to look for CDs with higher interest rates to make it worth losing liquidity.  

What Happens to a CD When It Reaches Maturity?

When a CD reaches maturity, the bank will pay the interest due according to the account agreement, usually into the CD account. At maturity, you have the choice to renew the CD or withdraw the funds. The grace period for this decision varies by bank policy.

Taxation on CD Investments

You will need to report all income from CDs on Form 1099-INT. This form is used for interest income. You will receive Form 1099-INT from your bank in the year interest is paid. 

Are CDs Worth It?

While other investment options can earn higher returns, they come with higher risk. CDs as part of a balanced investment portfolio can be a smart investment option. They offer low risk with the possibility of higher interest rates than savings accounts or money market accounts. Ready to get started? Find the best six-month, one-year or five-year CD rates.

Frequently Asked Questions