What a CD is and how your money grows
A certificate of deposit is an agreement between you and a bank: you give the bank a lump sum of money, agree to leave it untouched for a set period of time, and the bank pays you a fixed interest rate in return. The bank uses your money to lend to other customers or invest it, and you receive a may provide return that is almost always higher than what a regular savings account offers.
You choose the term length when you open the CD—typically three months, six months, one year, three years, or five years. The longer you lock your money away, the higher the interest rate the bank will offer. At the end of the term, called the maturity date, the bank returns your original deposit plus all the interest you earned. The interest compounds, meaning you earn interest on your interest, though how often that happens (daily, monthly, or at maturity) depends on the bank's terms.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. This means if the bank fails, your money is protected up to that limit. This protection is one reason CDs are considered very low-risk.
Key Takeaways
- You deposit a fixed amount of money for a fixed period, and the bank pays you a may provide interest rate that does not change.
- The interest rate is higher the longer your term, so a five-year CD pays more than a three-month CD at the same bank.
- Your money is locked in until the maturity date; withdrawing early usually costs you a penalty that reduces your earnings.
- When your CD matures, you can withdraw the money, open a new CD, or let the bank automatically renew it on the same or different terms.
- FDIC insurance protects your deposit and interest up to $250,000 if the bank fails.
How interest rates are set and what you actually earn
Banks set CD rates based on what the Federal Reserve does with short-term interest rates. When the Fed raises rates, banks typically raise CD rates too. When the Fed cuts rates, CD rates fall. The bank also considers how long you are locking your money in—a longer commitment usually means a higher rate because the bank has your money for longer and can plan around it.
Your actual earnings depend on three things: the principal (the amount you deposit), the annual percentage yield or APY, and the term length. APY includes both the interest rate and how often it compounds. A bank might advertise a 4.5% APY on a one-year CD. If you deposit $10,000, you will earn roughly $450 in interest over the year, though the exact amount depends on whether interest compounds daily, monthly, or at maturity.
Interest rates vary significantly between banks. A credit union might offer 5.0% APY on a one-year CD while another bank offers 4.2% for the same term. Shopping around before you open a CD can mean hundreds of dollars in difference over the life of the account. Online banks typically offer higher rates than brick-and-mortar banks because they have lower overhead costs.
What happens if you need the money before maturity
This is where CDs differ most from regular savings accounts. If you withdraw money before the maturity date, you pay an early withdrawal penalty. The penalty amount varies by bank and by term length. A three-month CD might have a penalty of one month's interest, while a five-year CD might have a penalty of six months' interest or more. Some banks calculate the penalty as a flat fee instead.
The penalty comes out of your earnings first. If you earned $200 in interest but the penalty is $150, you get back your original deposit plus $50. If the penalty exceeds your interest, the bank takes the difference from your principal. This means you could end up with less money than you started with if you withdraw very early from a long-term CD.
Before you open a CD, read the disclosure document the bank provides. It will state the exact penalty for early withdrawal. Some banks offer "no-penalty CDs" that let you withdraw without a penalty, but these come with lower interest rates to compensate the bank for the flexibility.
How maturity works and what your options are
On your maturity date, the bank stops holding your money in the CD. At this point you have three choices: withdraw the money, open a new CD with the same bank, or do nothing and let the bank automatically renew your CD.
If you choose to do nothing, most banks will automatically renew your CD on the same term at whatever the current rate is. This happens within a few days of maturity. If rates have fallen, your new rate will be lower. If rates have risen, your new rate will be higher. Some banks give you a grace period—usually seven to ten days—where you can withdraw the money without penalty even though the renewal has already happened. Check your account statements or call the bank to confirm the grace period.
If you want to move your money elsewhere, withdraw it during the grace period or before renewal happens. The bank will send you the funds via check, ACH transfer, or wire transfer depending on what you request. There is no penalty for withdrawing at maturity.
Comparing CDs across banks and terms
The best CD for you depends on when you will need the money and how much you want to earn. A table can help you see the trade-offs:
| Term Length | Typical Rate Range | Best For | Risk if You Need Money Early |
|---|---|---|---|
| 3 months | 4.0% to 4.5% APY | Money you might need soon; testing the CD strategy | Low penalty, but very little interest earned |
| 1 year | 4.5% to 5.0% APY | Money you will not need for a year; good balance of rate and flexibility | Moderate penalty; you lose several months of interest |
| 3 years | 4.8% to 5.2% APY | Money you are certain you will not touch; higher earnings | High penalty; could lose half a year of interest |
| 5 years | 5.0% to 5.5% APY | Long-term savings; maximum earnings at current rates | Highest penalty; could lose six months or more of interest |
When you compare CDs, look at the APY, not just the interest rate. APY accounts for compounding and gives you the true annual return. A bank advertising 5.0% APY is more transparent than one advertising 4.88% interest compounded daily, even though they might be similar.
Also check whether the bank charges monthly maintenance fees or requires a minimum deposit. Some banks require $1,000 or $2,500 to open a CD. Others have no minimum. A $10 monthly fee on a small CD can wipe out much of your interest earnings.
Tax implications and how interest is reported
CD interest is taxable income. The bank will send you a Form 1099-INT in January showing how much interest you earned during the previous year. You report this on your federal tax return, and you owe income tax on it at your regular tax rate.
This matters because it reduces your real return. If you earn $500 in CD interest and you are in the 24% tax bracket, you owe $120 in federal tax. Your actual take-home is $380. Some people keep this in mind when deciding between a CD and other investments, though CDs remain attractive because the rate is may provide and the risk is zero.
If you hold a CD in a retirement account like a traditional IRA or Roth IRA, the interest is not taxed until you withdraw from the account (or never, in the case of a Roth). This is one reason some people use CDs as part of a retirement strategy.
Frequently Asked Questions
Can I add money to a CD after I open it?
No. A CD is a fixed contract. You deposit the full amount upfront and cannot add to it. If you want to invest more money, you open a separate CD. Some banks let you open multiple CDs at the same time with different term lengths, which is called a CD ladder.
What is a CD ladder and why would I use one?
A CD ladder means opening multiple CDs with different maturity dates—for example, one that matures in one year, one in two years, and one in three years. As each CD matures, you can reinvest it or withdraw it. This gives you regular access to portions of your money while still earning higher CD rates on the rest. It also lets you take advantage of rising rates by reinvesting maturing CDs at higher rates if the Fed has raised them.
What happens to my CD if the bank fails?
The FDIC insures your CD up to $250,000. If the bank fails, the FDIC will transfer your CD and all accrued interest to another bank, or pay you the full amount. You will not lose money. The FDIC limit applies per depositor per bank, so if you have $300,000 in CDs at one bank, only $250,000 is insured.
Is a CD better than a savings account?
CDs currently pay higher interest rates than savings accounts at the same bank, often 0.5% to 1.0% more APY. The trade-off is that your money is locked in. If you need liquidity—the ability to access your money without penalty—a high-yield savings account is better. If you have money you will not need for months or years, a CD usually pays more.
Can I move a CD to another bank?
You cannot transfer a CD directly. When it matures, you can withdraw the money and open a CD at a different bank. You can also withdraw early from your current CD (paying the penalty) and open a CD elsewhere, though the penalty usually makes this uneconomical unless rates have risen significantly.