Once your CD is established and funded, the bank or credit union will administer it like most other deposit accounts, with either monthly or quarterly statement periods, paper or electronic statements, and usually monthly or quarterly interest payments deposited to your CD balance, where the interest will compound.
Unlike most other investments, certificates of deposit offer fixed, safe—and generally federally insured—interest rates that can often be higher than the rates paid by many bank accounts. CDs have become a more attractive option for savers who want to earn more than most savings, checking, or money market accounts pay, but without taking on the risk or volatility of the market.
Certificates of deposit are a special type of savings instrument. In return for giving up access to your funds, CDs generally pay higher interest rates than savings or money market accounts. This rate represents the interest that banks pay to borrow money through the Fed. When Fed money is cheap i. But when the federal funds rate is moderate or high, banks can do better by paying consumers a competitive rate for their deposits. In December , the Fed reduced its rate to the lowest level possible of essentially zero as a stimulus to lift the U.
Even worse for savers was that it left rates anchored there for a full seven years. During that time, deposit rates of all kinds—savings, money market, and CDs—tanked. Beginning in December , however, the Fed began to gradually increase the federal funds rate in light of metrics showing growth and strength in the U. As a result, the interest banks were paying on deposits was rising, with the top CD rates an attractive option for certain cash investments. These lower rates currently make CDs a less attractive option for cash investors.
Opening a long-term CD right before a Fed rate hike can hurt your future earnings, while expectations of decreasing rates can signal a good time to lock in a long-term rate. By contrast, an exceptionally large bank with more than sufficient deposit reserves may be less interested in growing its CD portfolio and therefore offer paltry certificate rates.
Certificates of deposit are one of the safest savings or investment instruments available, for two reasons. CD investments are also protected by the same federal insurance that covers all deposit products. Bank failures are exceptionally rare these days. Certificates of deposit are useful in a few different situations. Or maybe you simply want some portion of your savings invested very conservatively, or shun the risk and volatility of the stock and bond markets altogether.
For money that you want to absolutely ensure will grow in value, even if modestly, certificates of deposit can fit the bill.
One of the downsides of CDs can also be a useful feature for some savers. One version of this is using CDs for your emergency fund. This allows you to ensure you always have sufficient reserves on hand in case of an emergency because the amount in the CD will never decrease. And though you may incur a penalty if you have to dip into your funds early, the idea is that you would only do this in a true emergency, not for lesser but tempting reasons. Pays a guaranteed, predictable rate of return, avoiding the volatility and losses that are possible with stocks and bonds.
Virtually every bank and credit union offers at least one certificate of deposit, and most have a wide array of terms on offer. So not only is your local brick-and-mortar bank an outlet, but so is every bank or credit union in your community, as well as every bank that accepts customers nationwide via the internet. In addition, you can open CDs through your brokerage account. Your brokerage firm simply serves as a middleman. Before the internet, your CD choices were essentially limited to what you could find in your community.
But with the explosion of online rate shopping, plus the proliferation of internet banks—and traditional banks opening online portals—the number of CDs one can consider is astounding. Note that the range of CD rates across different institutions can vary widely. You should shop for options available within your state or community, with several online tools able to filter these results and aid in your search. The top-paying CDs in the country typically pay three to five times the national average rate, so doing your homework on the best options is a key determinant on how much you can earn.
Each bank and credit union establishes a minimum deposit required to open each CD on its menu. Sometimes a bank will set a minimum deposit policy across all CD terms it offers, while some will instead offer rate tiers, providing a higher APY to those who meet higher minimum deposits.
In theory, having more funds available to deposit will earn you a higher return. There are two important considerations when deciding how long a CD term is right for you. The first centers on your plans for the money. Smart CD investors have a specific tactic for hedging against rate changes over time and maximizing their returns. At the outset, you take the amount of money you want to invest in CDs and divide it by five. You then put one-fifth of the funds into a top-earning 1-year CD , another fifth into a top 2-year CD , another into a 3-year CD , and so forth through a 5-year CD.
Then, when the first CD matures in a year, you take the resulting funds and open a top-rate 5-year CD. You continue doing this every year with whichever CD is maturing until you end up with a portfolio of five CDs all earning 5-year APYs, but with one of them maturing every 12 months, keeping your money a bit more accessible than if all of it were locked up for a full five years.
The reason this is important is that, when some banks and credit unions offer a promotional CD to attract new customers, they may stipulate an unconventional term. It may be to stand out or, perhaps, to match the birthday the bank is celebrating or any number of other reasons. But if you can be flexible in considering these odd-term certificates instead of the conventional term you were planning, you can sometimes find yourself with a better-paying opportunity. When you hold a CD, the bank will apply interest to your account at regular intervals.
This is usually done either monthly or quarterly and will show up on your statements as earned interest. Just like interest paid on a savings or money market account , it will accumulate and be reported to you in the new year as interest earned, so that you can report it as income when you file your tax return. Sometimes people get confused about this because they are not able to actually withdraw and use those interest earnings. So their expectation is that they will be taxed on the earnings when they withdraw the CD funds at maturity or sooner if they cash out early.
This is incorrect. For tax-reporting purposes, your CD earnings are taxed at the time the bank applies them to your account, regardless of when you withdraw your CD funds. Its communication will also include instructions on how to tell them what to do with the maturing funds.
Typically, they will offer you three options. In any case, the communication to you will stipulate a deadline for you to provide instructions, with an indication of what the institution will do in lieu of receiving your guidance. In many cases, its default move will be to roll your proceeds into a new certificate.
As a general rule, letting your CD roll over into a similar CD term at the same institution is almost always unwise. But it's also virtually never the path of maximum return.
And the odds are low that the bank where your CD is maturing is currently a top-rate provider among the hundreds of banks and credit unions from which you can choose a CD. Whether you encounter an emergency or a change in your financial situation—or simply feel you can use the money more usefully or lucratively elsewhere—all banks and credit unions have stipulated terms for how to cash your CD out early.
The most common way that financial institutions accommodate a premature termination is by assessing an early withdrawal penalty EWP on the proceeds before your funds are distributed, according to specific terms and calculations that were set out in your deposit agreement when you first opened the certificate.
This means you can know before you agree to the CD if the early withdrawal penalty is acceptable to you. You will generally still have earnings, as the EWP will usually only eat up a portion of your earned interest.
Learn more about CDs at Bank of America. The material provided on this website is for informational use only and is not intended for financial, tax or investment advice.
Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional and tax advisor when making decisions regarding your financial situation.
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Close 'last page visited' modal Welcome back. Here's where you left off. Show related content Don't show me this pop-up of the page I left off on again. You might also be interested in:. Skip to main content. My Priorities Search. If you have funds that you want to keep safe for anywhere from a few months to a number of years, a CD could be a good way for you to save. The early-withdrawal penalty on a CD encourages you to keep your money in the bank rather than spend it. CD interest rates generally go up as the term increases.
Common time periods for CDs are three, six, 12, 24 or 60 months. Take care not to sign up for a CD with a maturity too far in the future. While a CD could be a good savings tool for many scenarios, there are a lot of reasons you may not want to put your money in a CD.
It depends on your financial needs and some external market conditions. For example, in the current interest rate environment , some high-yield savings accounts pay better interest rates than CDs. If you can earn more interest without any time requirements, you may be better off with a more traditional savings account than a CD. You should also compare your interest rate from your CD with the current inflation rate. Some critics of CDs point out that inflation rates may rise over time to be higher than CD interest rates.
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