A CD is a savings account where you lock up your money for a set time in exchange for a may provide interest rate

A certificate of deposit (CD) is a contract between you and a bank. You give the bank a lump sum of money—anywhere from $500 to $100,000 or more, depending on the bank—and agree not to touch it for a fixed period. In return, the bank pays you a fixed interest rate, usually higher than what a regular savings account offers. When the term ends, you get your original money back plus the interest earned.

The bank uses your money during that time to make loans or invest. That is why they pay you more than they would if you could withdraw whenever you wanted. The tradeoff is simple: you give up access, and the bank gives you a better rate.

CDs are FDIC insured at most banks, meaning if the bank fails, the federal government protects your deposit up to $250,000. That makes them one of the safest places to park money if you do not need it right away.

Key Takeaways

  • You deposit a fixed amount for a fixed term—typically three months to five years—and receive a may provide interest rate that does not change.
  • Your money is locked in; withdrawing early usually costs you a penalty that eats into or eliminates the interest you earned.
  • CDs are FDIC insured up to $250,000 per depositor per bank, so your principal is protected even if the bank fails.
  • Interest rates on CDs vary by bank, term length, and economic conditions, so shopping around can mean hundreds of dollars in difference over the life of the CD.
  • When your CD matures, the bank automatically renews it at the current rate unless you tell them to do something else with the money.

How the term and interest rate work together

When you open a CD, you choose how long to lock your money away. Common terms are three months, six months, one year, two years, three years, and five years. Some banks offer longer terms or shorter ones. The longer the term, the higher the interest rate the bank usually offers—because they want to keep your money longer and you are giving up more access.

The interest rate is fixed, meaning it does not move for the entire term, no matter what happens in the economy or what the Federal Reserve does. If you open a one-year CD at 4.5%, you will earn 4.5% for the full year, even if rates drop to 2% or rise to 6%. That certainty is one reason people choose CDs: you know exactly what you will have at the end.

Interest compounds, usually daily or monthly depending on the bank. That means you earn interest on your interest. A $10,000 CD at 4.5% for one year will grow to about $10,450 by maturity. The exact amount depends on how often the bank compounds.

What happens if you need the money before the term ends

This is where CDs hurt. If you withdraw money before the term is up, the bank charges an early withdrawal penalty. The penalty varies widely—some banks charge three months of interest, others charge six months or a full year's worth. A few charge a flat dollar amount instead.

On a small CD or a short-term one, the penalty might wipe out all the interest you earned. On a larger CD or a longer term, you might still come out ahead even after the penalty. Before you open a CD, read the disclosure document and find out exactly what the penalty is. Do not guess.

Some banks offer no-penalty CDs that let you withdraw without a penalty, but they pay lower interest rates to make up for that flexibility. If you think you might need the money, a no-penalty CD is worth comparing to a regular CD, even if the rate is lower.

Shopping for the best CD rate

CD rates change constantly and vary from bank to bank. A big national bank might offer 3.5% on a one-year CD while an online bank offers 4.8% for the same term. That difference compounds: on a $25,000 CD, it means roughly $325 more in your pocket after one year.

Online banks and credit unions often pay higher rates than brick-and-mortar banks because they have lower overhead costs. You can compare rates on sites that track CD offerings, but you will still need to go to each bank's website to open the account. There is no single place to buy a CD across multiple banks at once.

When you are comparing, make sure you are looking at the same term length and the same deposit amount. A bank might offer 5.0% on a five-year CD but only 3.8% on a one-year CD. Also check whether the rate is may provide for the full term or whether it can change—most are may provide, but some promotional rates are not.

What happens when your CD matures

When the term ends, your CD reaches maturity. The bank sends you a notice, usually 10 to 30 days before the maturity date, telling you what will happen next. You have a window—usually 7 to 10 days—to decide what to do with the money.

If you do nothing, most banks automatically renew the CD at the current rate for the same term length. If rates have dropped, you might not like the new rate. If rates have risen, you might wish you had locked in the higher rate earlier. Either way, you can withdraw the money without penalty once the CD matures, or move it to a different CD at a different bank.

Some people use a CD ladder strategy to manage this: they open multiple CDs with different maturity dates so that money comes due at regular intervals. That way, if rates rise, you can reinvest maturing CDs at the new higher rate without waiting years for your entire balance to mature.

CDs versus savings accounts and money market accounts

A regular savings account is more flexible but pays less interest. You can withdraw anytime without penalty, but the interest rate is usually 0.01% to 0.5%, far below what a CD pays. A money market account sits in the middle: it pays more than a savings account but usually less than a CD, and it lets you write checks or make a limited number of withdrawals per month.

If you know you will not need the money for at least a few months, a CD almost always pays more. If you might need it sooner, the flexibility of a savings account is worth the lower rate. Some people split the difference: keep three to six months of expenses in a savings account for emergencies, and put longer-term money in CDs.

CDs also differ from bonds and stocks, which can go up or down in value. A CD is a fixed contract—your principal never changes, and your return is may provide. That makes CDs safer but also means you will not get rich quick. They are a tool for parking money safely while earning more than a savings account.

Tax treatment and reporting

Interest earned on a CD is taxable income in the year you earn it, even if you do not withdraw the money. If you earn $450 in interest on a CD in 2024, you owe income tax on that $450 in 2024, whether you leave it in the CD or take it out.

The bank will send you a 1099-INT form in January showing how much interest you earned. You report that on your tax return. If you have multiple CDs or other savings accounts, the interest from all of them gets added together on your return.

If you withdraw money early and pay a penalty, you can deduct the penalty from your taxable interest income on your tax return. So if you earned $500 in interest but paid a $150 penalty, you report $350 as taxable interest. Keep records of any early withdrawal penalties you pay.

Frequently Asked Questions

Can I add more money to a CD after I open it?

No. A CD is a fixed contract for a fixed amount. Once you open it, you cannot add to it or withdraw from it without paying a penalty. If you want to invest more money, you open a separate CD.

What if the bank fails while my money is in a CD?

The FDIC insures your CD up to $250,000. If the bank fails, the FDIC pays you the full amount of your CD plus any accrued interest, even if the bank has no money left. This protection applies to each depositor at each bank separately, so if you have CDs at two different banks, each is insured up to $250,000.

Is a CD a good place to put money I might need in a year?

If you are certain you will not need it for a full year, a one-year CD is a solid choice and pays much more than a savings account. If there is any chance you might need it sooner, the early withdrawal penalty could cost you hundreds of dollars. A no-penalty CD or a savings account is safer if you are unsure.

Do I have to use the same bank for all my CDs?

No. You can open CDs at different banks to shop for the best rates and to spread your deposits across multiple banks if you have more than $250,000 (since FDIC insurance covers only $250,000 per bank). Many people open CDs at online banks for higher rates and keep a savings account at a local bank for convenience.

What happens to my CD if interest rates drop after I open it?

Nothing. Your rate is locked in for the full term. You keep earning the same rate you agreed to, even if the bank is now offering lower rates to new customers. This is one advantage of CDs: you are protected from rate drops, though you are also locked out of rate increases.